Welcome to The Outlook archives, where you can view several past issues featuring our investment and economic thinking. The Outlook is available in both PDF* and HTML format. We recommend that you review the PDF format, as it is closer in appearance to our printed version.
Looking Through the Politics – Why Equities Should Benefit from A Low-Growth Environment
The character of the post-crisis US economy augers well for a period of continued low growth, low inflation, low interest rates and rising corporate profits. One of the reasons this period has been so challenging for investors is that we are operating in an economic and investment environment that is unprecedented. While certain characteristics of this period are reminiscent of those past, there are critical differences as well. Few investors have operated in an environment that enjoyed the prospects for reaccelerating US manufacturing growth along with expectations of continued low inflation and near zero interest rates for a sustained period of time. The political dysfunction in Washington highlighted by the debt and deficit debate will likely continue to be a major distraction for investors until a long-term solution is established, but investors who take a longer-term view should be well rewarded.
A Favorable Environment for US Equities
The past few years have seen a significant shift in the trajectories of the major global economies. After coordinated efforts to reflate the global economy following the 2008 crisis, the cumulative effects of monetary and fiscal policy have put the US at the forefront of a successful emergence from the financial crisis relative to Europe and Japan. At the same time, China and the commodity-driven economies are struggling to rebalance their economies while maintaining acceptable growth rates. The US is undergoing a robust recovery in the housing, automotive and industrial sectors, making it an attractive market in which to invest. Among the key factors driving US industry is the energy sector’s ability to dramatically reverse decades of production declines which is resulting in lower energy prices and giving domestic manufacturers a significant production cost advantage. US corporate profits are also benefitting from lower capital costs and limited labor inflation, which are the same factors that are allowing the Federal Reserve to maintain its near-zero interest rate policy and creating the conditions for a potentially extended business cycle. The current combination of benign inflation, low interest rates and rising corporate profits is conducive to valuation multiple expansion and is favorable for equity investing.
Disinflation, Low interest rates and the move to US Energy Independence
Throughout our 40-year history, the firm’s views on inflation, interest rates and corporate profits have been fundamental to shaping our Outlook and investment portfolios. Today, it is our view that the forces of disinflation remain powerful and have important implications for portfolio strategy. We continue to anticipate low interest rates for possibly several more years as the Federal Reserve targets for inflation and unemployment are not likely to be reached until at least 2016. Clearly macro concerns remain; however, there are distinct positive secular and cyclical trends taking place in the US today, and corporate profits, margins and market valuations should be strong for those industries and select companies that are best positioned to benefit.
Investing in a Low Growth, Zero Interest Rate Environment
For the past three quarters, ARS has expressed the view that event-driven or general economic concerns were masking several positives in the US and around the world. The global economy has proven to be more resilient than many expected due to several factors including historically low interest rates and inflation rates, aggressive policy actions, and gradual improvement of several important economic indicators in the US (housing, unemployment and consumer confidence) and China (inflation and manufacturing). Further, there even have been signs of changing sentiment towards Europe, which has weighed heavily on the global economy the past few years, as yields in the most economically challenged countries have declined from crisis levels. In recent months, central banks have embarked on a yet more expansive monetary policy at a time when the global business cycle is showing signs of reaccelerating. Unlike previous business cycles where central bank policy was neutral to becoming restrictive as conditions improved, central bank policy is now designed to address the chronic unemployment problem in the developed world which has negatively impacted economic output. There are several positive developments in the world’s second (China) and third (Japan) largest economies which should aid global growth this year. These and other forces discussed in this Outlook have the potential to reverse the multi-year trend of fund flows from equities into fixed income.