Bias for U.S. equities is positive

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The U.S. economy has been walking around in a daze since it fell off that cliff in 2008, but if America can get its mojo back, 2011 could prove to be a turn around year.

Economic growth south of the border could even outstrip Canada’s, according to a report from Scotia McLeod, provided the housing situation stabilizes.

“Everyone is so darn pessimistic,” says Scotia McLeod’s U.S. equities portfolio manager, Vincent Delisle. “The U.S. consumer has been surprisingly resilient and the S&P 500 is outperforming, but nobody talks about that.

“We like what we are seeing in the U.S. right now. We think economic activity has been picking up since the lulls of last summer. We expect job growth to improve over the next few months and that should support further profit growth and a higher S&P 500.”

A Bank of Montreal economic forecast sees the U.S. economy growing at somewhere between 2% and 2.5% in the first half of the year.

“It will be a tough slog for the first 6 to 8 months of the year,” says BMO Capital Markets economist Benjamin Reitzes. “But by the second half of the year, we have things improving. We should see more jobs coming, and that should turn into a virtuous cycle of hiring and spending that should boost the economy going into 2012.”

The U.S. federal debt still looms large but there are signs America is working on its structural problems and its tower of debt is seen as a long-term problem – not one for the short-term.

While Canadians have been piling on record household debt, Reitzes says American householders have been pulling themselves out of the red. Interest rates remain low and continued weakness in the greenback should leverage demand for U.S. exports, particularly for high value U.S. manufactured goods.

BMO expects unemployment to drop to 9.2% by the end of 2011, down from the current 9.8%.

While U.S. growth still doesn’t hold a candle to growth in emerging markets and the unemployment rate is still nasty, “the U.S. story is moving forwards not backwards,” says Reitzes.

And never forget the U.S. economy is still six times the size of China’s economy and that the America represents a highly motivated, entrepreneurial society with vast intellectual capital they can put to work.

“We’ve seen huge increases in productivity in the U.S.,” says Grayson Witcher, U.S. equities manager for Mawer Investments in Calgary. “I think that increase is under-appreciated. I am talking about cloud computing firms, smart grids for energy and global communications systems. Technological innovation like that can really boost growth in the U.S. and when times are tough for the U.S. people tend forget about the American capacity to innovate.”

The other unappreciated fact says Witcher, is that the U.S. is really a global player. “The fact is that U.S. companies are really multi-national companies with a lot of international exposure,” he says.

“Forty percent of the underlying revenues in our U.S. portfolio, which is not too much different from the S&P 500 index, come from outside the U.S.,” says Witcher.

“When you look at valuations for some of the big U.S. equities, they aren’t as attractive as they were a year ago, but they still look good,” he says. “The price to earnings ratio for the S&P 500 is a little over 15 times trailing and a little over 14.5 going forward.”

The U.S. has also been benefiting from mergers and acquisitions. “You get growth through M&A without investing much capital,” he says.

Scotia McLeod is looking for the S&P 500 to hit 1,325 in 2011. “That’s about an 8 to 10% return,” says Delisle.

On the down side, interest rates will likely shoot up in 2011 or early 2012. “We think the 10-year-bond rate will continue falling over the next few months and bottom out in March or April at 2.4%,” BMO’s Reitzes says. “Then when the economy starts to pick up, the bond markets will start to post higher rates, likely around 3.65%, in anticipation of an eventual Fed rate hike in early 2012.”

“I think the number one risk heading into 2011 for global markets and the S&P 500 is what China does in terms of monetary policy,” Delisle says. “China may continue to raise interest rates and try to slow down its economy and that could add some volatility to the markets in the first part of 2011.”

The missing ingredient in the U.S. equities story is something that has been absent for quite a while. “Its confidence,” says Delisle.

“I am talking about business and consumer confidence. This will only rebound when the U.S. starts adding jobs at a more dynamic pace,” he says. “I think in the balance everything will be driven by how many jobs are added to the U.S. economy.”

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