Five years after a devastating housing meltdown in the United States, money managers are breaking out the champagne. In January new home sales jumped 16 per cent to their highest level since 2008. In February the indicator for U.S. consumer confidence blew away expectations – the index stood at 69.6, up substantially from the 58.4 registered in January.
The question is this: In a land where consumer spending accounts for 70 per cent of GDP, can a reinvigorated consumer brighten prospects for the U.S. economy?
"When things are bad we feel good by spending money. When things are good we overspend. When we don't have enough, we borrow more money to spend," says New York-based Penn Financial president Matt McCall, who is positioning his client's portfolios for a consumer-led U.S. economic recovery.
He's not alone. March marks the start of the fifth year of a bull market in U.S. stocks that has more than doubled the value of the S&P 500 – a trend he feels will accelerate and catapult the index to a new high. "When we have a fifth year of a bull market the average gain of that year is 20 per cent, which is kind of like a blow-off top."
Mr. McCall points to the S&P 500's average price-to-earnings ratio of 15, which he says shows current stock prices are low compared with expected company earnings. "We should be upwards of 16.5 on the S&P 500, which from here is another 10 per cent."
He believes a lethal mix of pent-up demand and rock-bottom interest rates will fuel housing and consumer stocks further. U.S. housing starts rose 24 per cent last year and inventories are currently at the lowest levels in more than a decade. "That's a good sign because that creates wealth in the mind of investors. They feel better about themselves and they go out and spend money, and that's great for the economy."
So far, investors do not seem to be deterred by the impasse in the U.S. House and Senate, where Republicans and Democrats are negotiating to avoid a government shutdown after a stopgap funding measure expires on March 27.
Mr. McCall investment of choice is the iShares Dow Jones U.S. Home construction exchange traded fund (ITB), which holds a basket of U.S. home builders, such as D.R. Horton Inc., Lennar Corp., Toll Brothers Inc. and even retail suppliers such as Home Depot Inc. and Lowe's Cos. Inc. Over the past year it has gained 70 per cent.
He's also making a secondary play on the housing revival through U.S. timber producer Rayonier Inc. "If housing is doing well you're going to have more demand for timber. It's a stock that we bought in the last two months that supplies a lot of wood to the housing industry."
On the consumer side he's buying Visa Inc., Apple Inc. and Coach Inc. for their growth potential in the United States, as well as their popularity in emerging markets. "Coach generates a large portion of its [leather-goods] sales in China and Asia. You're looking at a high-end luxury play and at the same time you're getting international exposure," he says.
To capitalize on emerging market growth he says more than half of his positions are growing revenue outside the United States – positions that include financials such as JPMorgan Chase & Co. and Bank of America. "You're not going to have any type of economic or stock market recovery without the financials behind it."
However, Moody's Markets Group chief economist John Lonski is far less optimistic about the fate of the U.S. consumer, or even the world's largest economy. "This recovery domestically has been quite disappointing," he says.
He sees U.S.-based multinationals such as Apple as the lone bright spots, suggesting the best U.S. investments are companies that invest outside the country. "Globalization of the U.S. economy has been great for corporate profits but it has slowed income growth for U.S. consumers," he says. "The U.S. worker cannot easily benefit from the same type of exposure unless they work for a company that happens to export products to China."
With unemployment stubbornly at 7.9 per cent, he points out that the United States still has 3.2 million fewer jobs than in January, 2008, making the current recovery the slowest on record since the Second World War. "Many metrics of economic activity have yet to return to their peaks of the previous economic recovery – especially as it relates to the labour market."
Specifically, Mr. Lonski says consumer spending has been maintained by record-high household debt, home sales still lag behind the averages of the late 1990s, and new-home construction is down 30 to 40 per cent from 20 years ago.
To make matters worse, he says recent signs of strength in the housing sector are deceiving. "The current recovery by housing is being led by sales of distressed housing as well as a pickup in purchases by investors, as opposed to being led by typical middle-class Americans," he says. "It is troubling that despite near record levels of home affordability and exceptionally low mortgage yields, the U.S. consumer has exhibited only a muted response to those incentives."
But it's what awaits the U.S. economy after the current bout of prosperity that Mr. Lonski finds most troubling. He cites recent data from the International Monetary Fund that shows the country's share of global GDP is expected to slide to 21 per cent by 2017 from 27 per cent in the 1990s and 30 per cent in the 1980s.
"In the past 10 years, average annual rates of growth were 1.6 per cent for advanced economies like the United States and Canada, and 6.6 per cent for emerging market countries. That particular imbalance will persist indefinitely."