A rising median household income, consumer finance improvements and encouraging wage growth data means the US economy is likely to experience three-to-five years of further growth, according to Lazard’s Ronald Temple (pictured), who said the country will experience a record-long recovery.
The managing director, who is also co-head of multi-asset investing and head of US equities, said there is also positive data coming from the likes of Europe, China and Japan, which makes for a positive economic story on a global basis.
As such, he is more positive on the global macroeconomic backdrop than he has been for more than 10 years (as discussed in an FE Trustnet article published in July this year) and said his confidence is growing as more new data feeds through. This is particularly in relation to the US, as he believes the economy is undergoing the “third leg” of its recovery.
“The first leg of the recovery was between 2009 and 2011 during QE [quantitative easing], fiscal stimulus and bank recapitalisation, which was more stabilisation than it was recovery,” Temple said.
“Then the second leg was between 2012 and 2014 which was QE, corporate profits and the wealth effects for financial assets came through. I think 2015 onwards is the middle-class consumer story.”
The managing director explained that, earlier this year, US household income data adjusted for inflation showed its biggest jump since the 1960s, between 2014 and 2015.
He said there was also a significant increase between 2015 and 2016, although this was marginally lower than the year before.
Performance of index between 2014 and 2016
Source: FE Analytics
“In 2015, the increase was 5.2 per cent and in 2016 was 3.2 per cent, which is obviously less strong but you have to keep in mind that median household income reflects three drivers,” Temple reasoned. “One is wage growth, another is the number of people per household who work and the third is inflation rates because it is inflation-adjusted.
“In 2015, part of the reason why the number was so high is because the oil price collapsed at the end of 2014, so there was a CPI [consumer price index] windfall that boosted the real number. 
Either way, if I put those two years together, it’s the single biggest two-year increase since the 1960s.”
The second piece of recent data to reaffirm his positive views on the US, according to the co-head of multi-asset investing, is the Triannual Survey of Consumer Financials, which was published last month.
“As of 2013, the richest 10 per cent of Americans had recovered all of their losses from the financial crisis and were 1 per cent wealthier in 2013 than in 2007,” explained Temple (pictured).
“The middle class however - the 25th to 75th percentile - was down 25 per cent from 2007 to 2013. Keep in mind that none of these numbers are inflation-adjusted so it’s even worse in real terms.
“We have since got the 2016 data. The loss for the middle class has been cut in half, so it’s now 13 per cent decline since 2007.”
As he expected, Temple said the wealthiest 10 per cent are now 34 per cent wealthier than they were in 2007, which means wealth inequality remains an issue and could continue to power the rise of populism.
However, he said the fact that middle-class losses have halved over three years is a positive factor consumer spending and therefore the US economy.
“Home prices are still the biggest drivers of consumer spending confidence in the US and they’re rising by 6 per cent per year for the average American consumer,” he added. “So, you can imagine being out of the hole in 2019 for the average middle-class households.”
The third piece of data to be released since July, according to Temple, is the real cumulative wage gains net of inflation for the average US consumer.
It analyses wage growth based on percentiles. For instance, the 95th percentile in the data will represent the highest-paid 5 per cent of US consumers.
From 2007 to the first half of 2016, the managing director said the bottom 70 per cent of US consumers had no real income growth for nine years. Meanwhile, he said the top 30 per cent saw material gains, particularly within among the very highest earners.
“From the first half of 2016 to the first half of 2017, every part of the wage spectrum had real wage gains, from the 10th percentile all the way to the 95th,” he said.
“To me, what that means is the labour market has finally become tight enough that you’re getting wage pressure for everyone, which should again feed back to that middle-class consumer.
“If they finally get wage increases then they’re more likely to have higher confidence, they’re more likely to consume more, they’re more likely to feel confident enough to buy their first home which drives up home prices. This then feeds back to the consumer balance sheet, which then creates more confidence and you get a virtuous circle.”
“I think the US has three-to five more years of growth and I think we’re going to have a record long recovery. So, things are good, and that even ignores positive stories in Europe, China and Japan. But I think the story globally is good.”
While the economic backdrop looks positive, Temple said it is important to tread carefully when buying into US equities at the moment as they are expensive.
Data from FE Analytics shows that, since 2009, the S&P 500 index has comfortably outperformed all other major equity indices with a total return of 257.36 per cent.
“In terms of developed markets, I like Europe in theory over the US because Europe has more profit recovery to come as it came out of recession later. But, what Europe does not have is the tax reform optionality,” the managing director said.
“I should note that my optimism on the US is not contingent on tax reforms. If we get a tax reform I think growth could be marginally higher, say 20 to 30 basis points, but I think there is about a 50 per cent chance of tax reform passing through Congress.
Performance of indices since 2009
Source: FE Analytics
“That said, if we do get tax reform in the US, I think that is far more important to earnings growth than it is to GDP growth. I think you could see - depending on the statutory tax rate – anything from a 10 to 15 per cent increase in earnings.
“You don’t have that in Europe and what bothers me about Europe is it is incredibly consensus. I think this could be a time where, if you actually get the tax reform, the people who are positioned in US equities could outperform Europe.”
That said, Temple warned that increasing inflows into US passives could present a headwind for active investors, given it will cause the asset prices of mega-cap FANGs [Facebook, Amazon, Netflix and Google] – which account for a large proportion of the index – to overinflate.
“For years, we have liked Google and Apple. These are great companies with great cash flow, great balance sheets and very competitive barriers to entry,” he said.
“But, as the market keeps pushing higher, there are limits where your valuations start to get a bit stretched. I do think that creates opportunities but it also creates challenges.
“We are finding some very good ideas in the US market. I think a bottom-up fundamental-driven investment style can do very well in this type of environment. We just have to do even more due diligence.”