Is it time to re-invest in the US?
America has had a truly terrible time over the last two years. But this year has seen a proactive new president, a turnaround in the equity markets, and some signs that the wider economy is in a less serious situation than it was.
Given that in previous slumps it’s always been the US that has led the rest of the world out of recession, many investors are asking themselves if they should be looking across the pond once again.
The stockmarket’s recent performance certainly suggests that recovery of some description seems to be underway, with the S&P 500 up almost 40% over the four months from its 9 March low point to mid July, according to Morningstar. However, unemployment stands at 9.5% and is expected to tip over 10% in the coming months, while the economy shrank by an alarming 5.5% over the first three months of the year.
But how did the US end up where it is today?
The 'end' of the American dream
We’ve all heard about the horrors of the sub-prime mortgage market, which lent large sums to people without the means to repay them. As house prices started to fall in the US during 2006 and 2007, more and more people were unable to pay their mortgages, and mortgage lenders and banks started going out of business.
That led eventually to the collapse of giants such as AIG, Lehman Brothers and Merrill Lynch last year. Companies stopped being able to borrow as bank lending dried up, and if they didn’t go bust altogether, many laid off workers and cut back on production in an effort to cut costs.
“Real fear took hold of America in the autumn,” explains David Forsyth, manager of the Martin Currie North America fund. “That was when the government started taking action, encouraging banks to buy other banks rather than let them go to the wall, and lowering interest rates.”
But the bulk of the rescue package has happened since President Obama came to power in January. First came the announcement of a massive $787 billion stimulus package, with tax cuts and huge infrastructure spending plans. That was followed in March by the promise of a $1 trillion ‘quantitative easing’ programme, under which the government put money into the banks by buying government bonds back from them.
Forsyth says: “The extra spending should work its way through the system over the next six to nine months.”
Paul Atkinson, a senior US portfolio manager for Aberdeen Asset Managers, agrees that Obama has helped to stabilise the economy. “There are concerns at the length of time it’s taking to get the stimulus money into the system – only $60 billion of the $787 billion has been spent so far.
But the promise gives confidence, which was completely lacking at the end of last year when industrial production and demand just ground to a halt,” he says.
The turning point for the economy came in April/May 2009, when companies had simply run out of stock and therefore had to start placing new orders again. Some economic statistics, such as new orders and industrial production, have started to improve since then.
However, the stockmarket seems to have turned the corner quite a bit earlier. “Its 40% rally since March shows it has taken on board the fact that the economy is stabilising,” points out Atkinson. Since May, after a couple of months of steady gains, the S&P 500 has been ‘treading water’; but experts are not agreed on what it all means – a breathing space in a new bull run, or a temporary blip in the ongoing sluggish market?
David Nelson, chair of the investment policy committee at Legg Mason, is quite bullish. He predicts that in the second half of the year, the economy will pick up and bring the market with it.
But many others are less upbeat about a sustained economic recovery. “That 40% rally was too strong to continue for any length of time, and it’s now really hard to know what will happen next – I think we need more confidence in the economy before we can be sure the upward movement will continue,” says Forsyth.
At Bestinvest, senior investment adviser Adrian Lowcock points out that consumers, who have tended to spend America out of recession in the past, are much less keen on running up debts and more focused on savings this time around.
“Recovery will be slow and we won’t see strong growth – but the US is still the world’s largest economy, so investors ignore it at their peril,” he says. Moreover, those firms that survive the credit crunch and recession are not only likely to be leaner and meaner, but also to have fewer competitors.
Indeed, despite the economic uncertainty, stockpicking US fund managers are generally quite perky at the moment. That’s largely because they are tapping into those American multinationals that are operating in fast-growing emerging markets.
Felix Wintle, the manager of Neptune’s US Opportunities fund, explains that although the US may be heading for recovery, “we won’t find dramatic economic growth there – that’s going on in China and the emerging markets. So we’re focusing in part on the sectors most exposed to those global growth stories – in particular, materials, energy and industrials.”
David Forsyth says the Martin Currie fund is also taking an international tack. “We’re looking for the US-based companies with huge brands that are best placed to pick up on strong growth globally – firms like McDonalds, Apple, Amazon, Google,” he says. “But we are also stockpicking in other specific areas that may offer international exposure, such as engineering.”
At Aberdeen, Paul Atkinson is also running a portfolio skewed towards firms with emerging market interests – recent purchases include the agri-biotech company Monsanto, which is very involved in efforts to boost crop yields.
But US fund managers also see opportunities ahead in the domestic economy. For example, Wintle points to the healthcare sector, where Obama’s plans for universal access to quality healthcare are likely to stimulate demand.
In the end, the US market remains a key sector to which every investor should have some exposure (how much will depend on your attitude to risk, but Bestinvest suggests around 7% to 10% of the total portfolio for cautious to moderate investors). Forsyth says: “North America does boast more than its fair share of the world’s most enterprising companies.”
Tracker or active management?
One important issue to consider is the fact that the US market is notoriously difficult for fund managers because it’s so well researched that few bargains lurk unnoticed.
“Historically, few funds consistently beat the US market – they do well for years, and then just seem to fall away,” says Ben Yearsley, investment manager at Hargreaves Lansdown.
Many advisers therefore suggest using an exchange-traded or tracker fund as a core holding; they are cheaper than an actively managed fund and give exposure to the whole S&P 500 index.
But Felix Wintle, manager of Neptune’s US Opportunies fund, says investors should forget about the index. “It does contain good firms, but also an awful lot of mediocre companies, which dilute the good firms’ impact,” he says. “The index hardly moves and it’s just not worth following.”
RECOMMENDED US FUNDS
Adrian Lowcock, senior investment adviser at Bestinvest, recommends: “For a core fund we’d use a good tracker, or maybe M&G American, which is a multi-asset fund, or the blue-chip Martin Currie North American. Smaller companies have done well, so I would add something like Schroder US Smaller Companies – but it’s relatively high-risk so it wouldn’t be a core holding.”
Philippa Gee, spokesperson for T Bailey, recommends: “Two active fund managers with strong teams that have consistently outperformed are Martin Currie North American and Axa Framlington American Growth. We also make use of L&G US Index for low-cost core exposure to the whole market, and we use exchange-traded funds extensively for the same reason.”
Philip Pearson, partner of P&P Invest, recommends: “Active managers we use include Neptune US Opportunities, Threadneedle American Select and Schroder US Smaller Companies. All have achieved above-average performance for relatively low risk.”
Property opportunities in the US
Investment opportunities are not limited to the stockmarket. Average prices in the US residential property market are a third down on their 2006 peak – and there are now some situations of serious undersupply and oversupply.
Mississippi, for example, is desperately short of decent housing in the wake of Hurricane Katrina, but developers are struggling to borrow funds.
“Letting agents have nothing at all to rent,” says Stuart Law, managing director of UK-based property investment company Assetz. The firm is working with offshore investors in a scheme to build 1,000 duplex (semi-detached) houses.
Investors can borrow up to 90% from the scheme to buy two homes at $280,000. Law says that rental income will amount to about £3,000 per year net of all costs (including borrowing costs) for both houses, and landlords could sell to their tenants when prices recover.
In Detroit, the housing crash and collapse of the car industry has caused massive problems for local homeowners. As a result, there are hundreds of repossessed homes and a 9,000-strong waiting list of would-be tenants needing affordable housing.
A large scheme is underway to buy these homes from the insolvency companies, refurbish them, sell them to private investors for between $27,500 and $45,000, and then let them through the government-run rental scheme, which pays most of the rent for the tenant. International property investment company Experience International is one company marketing the scheme in the UK.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.