Reading the newspaper these days, it seems to be full of bad news. Negative headlines relating to trade wars, stuttering housing markets, inflation risk, Kardashian family break-ups, or a dysfunctional White House seem to be a daily occurrence. It’s hard to separate fact from fiction and the “Twitter” President doesn’t help.
But are things really that bad?
A key part of our investment process is getting out and meeting companies, “kicking the tyres” if you like. Having just returned from two weeks in the US, meeting over 40 companies from a range of industries, I wanted to share the key themes of my research trip. In short, the US economy is “booming”. My domestic flights were full, airports were buzzing, restaurants were overflowing and the skylines in Chicago and Boston were full of cranes. What is striking is the optimism in the country, Americans have the spring back in their step. Let me tell you more.
Company management I met were uniformly positive, with many smaller companies suggesting the backdrop was the best they had seen in years. Tax reform and the deregulation push were seen as big positives, outweighing any concerns surrounding trade tensions. Smaller companies have disproportionately benefited from tax reform as they’ve historically paid higher taxes than larger companies. The lighter regulatory “touch” was also viewed positively. Under the Trump presidency, two regulations must be removed for every new one introduced. This renewed optimism is reflected in the National Federation of Independent Business optimism index, a monthly survey of small businesses. The chart below shows small business confidence is now the highest it’s been in the last 35 years.
US small business confidence
The majority of companies I met mentioned the tight labour market and the difficulty in finding workers with the necessary skills. For example, the largest US railroad companies are having to offer US$25,000 sign-on bonuses to attract train drivers. Apparently, truck drivers are as “rare as hen’s teeth” and are earning six-figure salaries. Some companies are so desperate, they are having to contact employees they previously fired to see if they are still available. If there are any young engineers out there, make your way to the US, where they tell me that for every five engineering jobs, there is only one engineer available. Write your own cheques apparently. Official economic data backs this up, with the US unemployment rate now 3.8% (see chart below), getting close to the lowest level since the 1960s. This is likely to underpin consumer spending which is the largest part of the US economy.
US unemployment rate
Source: JP Morgan
Housing market still healthy
I met two of the largest home builders in the US and both dismissed concerns surrounding the impact of rising interest rates on housing demand. They see the housing cycle as “still having legs”, citing pent-up demand, a strong job market and affordability still sound. Mortgage rates continue to be seen as low relative to history. However, cost pressures are building, for example, lumber costs are up over 60% in the last year. But it’s not just lumber, costs of building materials in general are rising, and finding skilled workers, such as plumbers, is becoming increasingly difficult. Encouragingly, homebuilders have pricing power and have been able to lift home prices to compensate for rising costs.
A sign of company optimism is the capital allocation decisions being made. After many lean years, companies have the confidence to invest again and encouragingly, research and development spending has reached a 15-year high. Tax reform is the key catalyst for the investment surge. A similar tax policy in 2003 unleashed an investment boom. It does appear the lion’s share of this investment is going to technology, hence the strong performance of the technology-heavy Nasdaq Index.
With inflationary pressure building, the hope is that this investment will lead to productivity improvements. Without getting too technical, productivity growth is one of the ways to boost economic growth, the other being labour force growth. A burst of productivity growth would add to the potential growth of the US economy and help offset the cost pressures in the economy. Time will tell if that is the case.
The US economy feels the strongest since the Global Financial Crisis and is carrying good momentum into the second half of 2018. This trip confirmed to me that regional dynamics are diverging, with the US accelerating and the rest of the world lagging. In terms of risks, inflationary pressure is building in the economy and will have to be watched closely. Any acceleration in inflation will likely impact the pace of interest rate rises. The other key risk is trade protectionism and is likely to be a hot topic until the mid-term elections in November. Overall, we do hope President Trump doesn’t shoot himself in the foot by damaging what our trip confirmed is a thriving economy.