The American economy is entering the new 2020 on solid foundations
- Composite Flash PMI ™ rose to 53.1 in January, the highest level since March 2019
- Growth is driven mainly by services, manufacturing is still struggling with a decline in exports
- Tariffs increase prices, but looking-forward indicators are improving
According to flash PMI IHS Markit data, in January business activity in the US increased at the fastest pace in ten months, and the growth rate accelerated for the third month in a row. The growth of new jobs has reached the highest level in six months, the optimism of companies regarding the future is constantly improving, it has reached the highest level since last June. The recovery was again driven by the service sector, manufacturing lagging behind, mainly due to falling exports. Costs have risen at the fastest pace in seven months, raised in many cases by tariffs and increased salary costs.
The beginning of 2020 – growth at the highest level in ten months
Adjusted for seasonal factors, the IHS Markit Flash US Composite PMI Output showed in January 53.1 compared with 52.7 in December, which means the fastest production increase since March last year. Historical comparisons suggest that the current PMI reading is broadly consistent with economic growth at a steady annual rate of around 2%:
Chart: IHS Markit US flash composite indicator:
Source: IHS Markit, BEA.
Service providers reported stronger growth than producers, suggesting that the former continued to be the main driver of GDP growth. The service economy more focused on the domestic market has been stimulated in particular by high consumer spending at low interest rates and a thriving labor market. The flash PMI employment rate rose to the highest level in six months in January, indicating a further solid increase in the number of non-farm payroll growth by around 150,000 duing month.
Expectations for output in the private sector improved at the beginning of 2020, optimism in January reached its highest level in seven months, suggesting that companies expect growth to accelerate in the coming months.
The increase in the current baseline and business sentiment index confirms the view that the Fed will maintain policy unchanged during upcoming meetings.
We predict US GDP growth of around 2% in 2020, which is close to the potential growth rate of the economy.
Ordinary dividends in the United States are projected to rise by around 7% and reach a record high of USD 670 billion in 2020.
- The dividend growth rate is expected to remain stable in 2020, despite flat profit growth prospects and ongoing US-China trade problems
- The technology, oil and gas, industrial goods and services sectors are expected to lead to a total aggregate payout
- Construction and Materials and Financial Services pave the way for dividend increases
- The Insurance sector will experience the greatest slowdown in dividend growth in 2020
The slowdown in dividend growth achieved this year is mainly due to the slowdown in profit growth compared to profit growth in 2018 (tax reduction). Looking to the future, we expect the 2019 dividend increase to pass to 2020, in which we expect rather flat revenues for companies and as yet a vague result of the trade war with China.
There are two areas of concern among the largest payers in the technology sector regarding their dividend sustainability. First, the potential for a permanent slowdown due to the continued uncertainty surrounding the US-China trade war. A trade war increases the cost of doing business, and without resolving this issue, many companies could be at risk of lower profit margins and higher costs passed on to their customers. Secondly, many companies are tested for antitrust laws. Qualcomm was under fire because of its monopolistic position in which customers paid excessive fees for the use of its patents. There are more examples. In turn, many leading technology payers have relatively large cash balances and low debt profiles, which strengthens the sector’s status among the largest payers. Much of the increase in dividends can be attributed to maintaining strong consumer confidence through efforts to increase productivity, replace human employees with technology, and the pace of technology evolution.
Microsoft and Apple are the companies with the largest share in the forecast dividend. In the case of Microsoft, we expect the company to increase their annual payment to USD 16.1 billion (an increase of USD 1.3 billion compared to last year), mainly due to a further increase in sales in all 3 segments: productivity and business processes, intelligent cloud and personal computers. Apple, we forecast the company will increase its dividend payout by USD 1.3 billion to USD 15.1 billion in the financial year 2020. Despite a slightly relaxed fundamental forecast due to trading conditions, profit is expected to increase by 10% and FCF is to cover a 4x dividend, which will affect our forecast that the normal 10% dividend growth rate will continue in the current financial year.
Chart: Ordinary US 2020 dividends by sector:
Source: IHS Markit, RCieSolution Research
The US stock market is in long-term upward hyperbola
US stock markets are in long-term growth hyperbola. Its feature is the accelerating upward trend. Increasing dynamics causes increasingly stronger emotions among investors, which entails increasing demand. The next step is to further accelerate the trend. It is a positive feedback loop that generally ends very rapidly.
The level 10K of the Nasdaq index in the perspective of a few months seems very likely. The market may reach this level, but it does not have to. We prefer hedging strategies to neutralize the downside risk and protect the portfolio value and are looking for alpha in strategies focused on volatility. We avoid directional risk without hedging.
According to our assessment, the market is in the final phase of the bull market. “Smart money” is probably at the final stage of stock distribution, the market is partly driven by passively managed ETFs (“street money” of which about half is managed by the Vanguard Group). On the other hand, in the face of money printing (QE4 is expected to start in Q2 2020, but from mid-August to the end of November 2019, the FED’s balance sheet has grown by nearly USD 300 billion to USD 4.05 trillion – that’s nearly USD 60 billion in liquidity provided monthly to banks) and low interest rates (“cash is the trash”), rich in cash, with a low debt profile, American companies are a tempting alternative. Let me remind you, the first 47 companies in the S&P500 index weigh half of the index (50.04%), in the Nasdaq index the first 9 companies weigh 51.4%, in the Dow Jones index the first 9 companies weigh 50.6%. There is a lot of money on the market looking for liquid investments. One thing to know: liquidity often works when the market is growing. In a situation of rapid sell-off, today liquid assets do not have to offer liquidity tomorrow. We are dealing with ‘easily available money’ which is directed to financial markets, a large number of unprofitable IPO companies, a surplus of cash in VC and PE funds often forced to invest surpluses in unprofitable ventures, a situation in which the FED buys government treasury instruments, maintaining low interest rates and financing the deficit. We suggest looking at historical interest rate levels and the deficit level in the US. If you are interested, please read our market report from June 2019: https://rciesolution.pl/en/market-report-june-2019/, in which we broadly describe the budgetary situation of the American government and put forward the thesis that the Fed will risk the market bubble phenomenon, what we are dealing with today. Structural problems are still valid: the growing deficit so far maintained by a low interest rate, rising wages still too low, economic uncertainty, increase in social inequalities, tax incentives that turn out to be expensive and fleeting, just to name a few.
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The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.