America the beautiful

PUBLISHED : Monday, 18 June, 2012, 12:00am
UPDATED : Monday, 18 June, 2012, 12:00am


If you Google the words 'Harbin Pharmaceutical Plant', you will find photos of a palatial interior. The facility has marble floors, paintings and chandeliers.

This is a listed company, with a market capitalisation of about US$2 billion, and investors might ask why the plant is so extravagantly decorated.

There is no easy answer to that question. But the firm may provide an insight into why the mainland economy is slowing. After decades of stellar growth and a massive state stimulus in 2008-09, China is showing signs of waste, of which marble flooring in a pharmaceutical plant is just the beginning.

I bring this up because there is a large, lean market that shows little of this excess. Its profit levels are high, its workforce is motivated and, because it has been something of a basket case for the past five years, its equities are out of favour and cheap. I refer to the United States.

We have become as accustomed to hearing bad news about the US as we have good news about emerging markets. But in my opinion the American economy is slowly and quietly on the mend.

We can see this from consumer confidence statistics to purchasing managers indices (which measure business confidence).

We forecast US economic growth of 2.1 per cent this year, and 2.2 per cent next year. These are not exciting numbers and a far cry from the 4.7 per cent average of the past 20 years. But it is the trend that is important, and the trend is positive.

US earnings are robust: these rose from US$1.25 trillion in 2009 to US$1.94 trillion last year (pre-tax). Even the US housing sector is perking up. Traffic of prospective buyers is the highest since July 2007, according to the National Association of Home Builders.

The same association's Home Builders Market index gauges builder perceptions of home sales at present and six months ahead. It has risen from a low of eight, in January 2009, to 29.

And let's not forget the many advantages in terms of resources, infrastructure and culture.

Shale gas and oil could make the country a net exporter of energy in the next 10 years. The US has a huge agricultural sector (China's is slightly larger, but it has 4.3 times as many people to feed), which will benefit from a rising world population.

Smart people have been going to the US to make it big since Alexander Graham Bell and Levi Strauss, and it's still happening.

Jerry Yang was born in Taipei, but he didn't found Yahoo in Taiwan. Sergey Brin was born in Moscow, but he didn't found Google in Russia. Eduardo Saverin was born in Sao Paulo, but he didn't co-found Facebook in Brazil (but he is moving to Singapore to cut his tax bill).

Often these entrepreneurs come to the US to attend its universities, and then stay. Its open society fosters creativity in ways closed societies cannot.

The missing ingredient is employment. After shedding 8.7 million jobs in the credit crisis, only 3.6 million have been added back.

There are several explanations for this. First, the recessions of the 1970s and early 1980s were caused by inflation and high interest rates, not excessive amounts of credit. When those came down, the jobs returned.

The credit binge that caused the recession in the late 2000s was exponentially larger than the savings and loans crisis that caused the recession of the late 1980s and early 1990s. Credit crises simply require a longer recovery time.

Globalisation also plays a part in explaining the high rate of unemployment in the US. In the 1960s, General Motors and AT&T were the largest companies by market capitalisation in the US; GM made its cars in Detroit and Bell System operators were in the US.

Today the world's largest companies by market capitalisation are Apple and Exxon Mobil (numbers one and two). Apple makes its iPhones on the mainland, and many Exxon employees are outside of the US, and customer service centre operators are based in India and the Philippines.

Economists and politicians are fixated on the high unemployment as it is a huge social problem. But it is not an investor problem.

Many big US stocks are global. They are thriving in international markets, which gives them profits and growth. The point is that, even if you are a sceptic about the American economic outlook, you can still have faith in the investment stories of big multinational firms domiciled in the US.

Many big US companies are doing very well (outside financials). They are leaders in their industries. They have a history of treating their minority shareholders with respect. They have steadily rising earnings. They have strong balance sheets. Think of Apple, Walt Disney, Nike, Coca-Cola, MasterCard or McDonald's.

I began this article talking about a mainland factory with marble floors and chandeliers. That is because US equities need to be seen in the context of global fund flows, particularly with regards to emerging markets. The message is simple: emerging markets are looking tired. Investors are starting to take money out of big developing nations such as Brazil, Russia and China, in favour of the US.

The week before last, for example, saw inflows of US$9 billion into US money market funds, according to EPFR, a research firm. Much of this was the proverbial flight-to-safety as a result of another flare-up in the euro-zone crisis. But tellingly, US$1.3 billion exited emerging market equity funds at the same time.

Mainland gross domestic product is trending down. India suffers from political inertia to which there is no end, as political parties prefer garnering votes with populist policies rather than implementing reform. Fund flows into the country are stalling (see sidebar). The Russian economy overly depends on commodities.

There are cyclical and macro factors that explain the emerging-market downturn, most particularly the euro-zone crisis.

But there is another, home-grown explanation, which is that their respective booms have resulted in wasteful investment, bad debt and over-consumption. There's plenty of anecdotal evidence.

Here, in Singapore, where I live, we are surrounded by emerging markets and deeply influenced by them. Seven years ago, Singapore was a good story to invest in: multibillion-dollar casinos were being built, celebrity chefs like Daniel Boulod and Wolfgang Puck were opening restaurants here. But something has changed, and thematically it seems a little like the kind of debt-fuelled overspending seen in the American consumer market just prior to the 2008-09 global credit crisis.

A few data points are illustrative. Last year, four of the five top-selling cars in Singapore were luxury brands (the only exception was Toyota). Dealers sold 10 times the number of Porsches, for example, as they did one decade earlier. Bear in mind that, because of taxes, a new Porsche starts at US$300,000 in Singapore. But they are as common a sight as Hyundais.

With echoes of the pre-2007 US housing boom, Singaporeans are buying the cars with generous amounts of leverage - purchasers are encouraged to pay as little down payment as possible, so car dealers can get bigger rebates from banks.

With car financing at 1.88 per cent, people are happy to take out 10-year loans on 100 per cent of the purchase. You even see luxury cars in the parking lots of public housing.

The question investors need to ask themselves is whether they want to be on the economy at the trailing end of long expansion resulting in unproductive investments and consumer high living, or do they want to bet on the frugal economy that puts every precious penny into those pursuits that promise long-term dividends.

If it's the latter, one might ask if the smart play these days is US equities.

Mark Matthews is the head of research, Asia, for Julius Baer.