In Europe, the Greek government and the EU (and the IMF) have been sparring in search of a resolution to the Greek debt crisis, while in China the communist government has been taking on its own markets by attempting to contain falling stock exchanges in Shanghai and Shenzen.
Against this backdrop I have just returned from the relative calm of a business trip to the US where I have been reviewing PM Capital’s holdings there, and also assessing other investment opportunities.
There is little doubt the US continues to be one of the most encouraging economies on the global stage, and I am pleased that the current headwinds in Greece and China will not, I believe, be sufficient to damage the ongoing recovery in the US.
My quick take on the US economy would be that the recovery is going to be longer and slower than what was originally envisaged, which we believe is no bad thing.
At the macro level the focus on that side of the Atlantic is not China, Greece or the EU but Janet Yellen and the Fed. When will the normalisation of interest rate policy commence? The market consensus is before Christmas and most likely around September, which is a timetable we subscribe to. This timetable may slip marginally but we are still factoring in at least one rate rise this year and possibly two, both of 25 basis points, with more to come in 2016.
For the record, here’s what Ms Yellen said in prepared remarks to the City Club of Cleveland in early July 2015:
“Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy….I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step.”
The predictable negative market reaction when the long-awaited event does occur, (despite Ms Yellen’s repeated telegraphing of her intentions) we believe, is likely to present buying opportunities, and that valuations of good companies will, over time, resume a path of modest growth.
We have been holders of US banks for some time and believe that the first rate rise in nine years will contribute directly to the bottom line of balance sheets of the likes of Wells Fargo, JP Morgan and Bank of America (BoA), all of which we currently hold. For instance the head of BoA recently noted that an increase in rates by one percentage point would directly add $4.6 billion to their pre-tax profits. Why?
Because like all banks they currently have huge deposits with the authorities earning zero interest.
The pricing of good US banks remains very attractive to us compared to their Australian counterparts. Price to book values are on average around 1.3 – 1.5x compared to 2.0 – 2.2x here.
In the US there is no regulatory risk overhang as the capital requirement of banks are not in play as they are here, notwithstanding the latest utterings of APRA on this subject, and the immediate outlook is one of positive earnings momentum.
We will likely maintain our holdings in this sector, and continue to accumulate on weakness.
We also hold real estate in the Las Vegas region via our position in the Howard Hughes Corporation (HHC) and remain comfortable with the outlook there and with HHC’s real estate portfolio in general, which includes significant holdings in Manhattan and Honolulu. We will continue monitoring companies in the consumer sector generally. We believe a growing economy will lead to increased consumer confidence and spending and that both the retail and beverage sectors will present opportunities.
It should be said that most of our business discussions in the US did include the subject of Greece. It represented an added injection of uncertainty to the general US outlook but the consensus of opinion, and one we share, is that whatever happens in Europe will not be of a scale or duration to permanently upset or interrupt the measured growth story that is the US economy. As for what happens in China, that’s another story.
Uday Cheruvu is portfolio manager at PM Capital
