Five ways to accelerate growth in the United States

Open Editor's Digest for free

Rula Khalaf, editor of the Financial Times, picks her favorite stories in this weekly newsletter.

Good morning. Dave Calhoun, CEO of Boeing, will step down. Unhedged's view of Boeing is that it won't bring investors back on board until it proves that the company's culture has fundamentally changed. This appears to be a step in that direction, but stocks have not reacted much. However, we think Boeing stock is a more interesting stock today than it was yesterday. Email us your opinion: robert.armstrong@ft.com and ethan.wu@ft.com.

What can go right in growth

Real GDP in the United States appears to be growing at a good, steady rate of 2 percent, which is right in line with the long-term economic growth potential. Risks remain: widespread pain among low-income consumers, a commercial real estate distress that hurts banks, and a deteriorating labor market as immigration slows above trend. Investors are prepared to sweat in such scenarios. But recently, there is an unusually high degree of optimism that growth will not only remain on trend, but may even accelerate. So here is an incomplete list of what might go right for US growth (there are overlaps between the points):

Cooperative inflation data creates a global cycle of lowering interest rates. Central banks have gained confidence that interest rates may fall soon, and one of these banks, the Swiss National Bank, has already begun cutting interest rates. This would boost global growth, with consequences for US exporters. Joseph Wang of the Fed Guy blog noted in a post yesterday that a global downturn could also increase risk appetite. The biggest reason is that banks and investors hold global investment portfolios, thus increasing the value of assets' across their portfolios [could] “It will have a greater mitigating impact than cuts in any single jurisdiction.” If so, a period of rapid deceleration in financial conditions and accelerating growth will likely follow.

The “wealth effect” raises spending. US stocks are up about 40 percent in the past year or so, and home prices are up 6 percent. Research suggests that the feeling of increased wealth boosts actual consumer spending, with wealthier consumers saving less and spending more of their income. Prevailing estimates are that a $1 increase in wealth generates 3 to 5 cents in additional spending. As the chart below from Moody's Mark Zandi shows, wealth is broadly rising:

Productivity in the United States continues to improve. Improving labor productivity would be the best path toward higher growth, in contrast to the wealth effect, for example, which might disintegrate if stocks fell for some reason. Why is this happening? We like Adam Posen's two-stage formulation, as mentioned in his interview with Unhedged last month. First, a tight labor market improves the fit between employees and employers; Well-matched workers do better work, enabling strong wage growth and profit margin expansion. Second, companies' investment in artificial intelligence is paying off, allowing companies to automate tedious processes and expand production.

Low mortgage rates create a huge return for housing. In the past three months, average interest rates on 30-year mortgages have fallen from about 8 percent to 6.9 percent. Importantly, this occurred without any interest rate cuts, driven instead by lower interest rate volatility which reduced the mortgage rate spread on Treasuries. Indeed, there has been an uptick in new mortgage applications and pending home sales. If interest rates are lowered, it could lead to the collapse of the existing home market, which has seen stagnant activity for two years. The contribution of housing investment to growth has recently returned to its long-term average after a long period of slow growth (see chart below). Will the revival of the housing market create an impetus for growth?

Manufacturing has finally emerged from its post-pandemic boredom. For nearly two years, the US manufacturing sector has experienced a prolonged recession, affected by a significant rotation between goods and services. But recently, some surveys of manufacturing activity have begun to pick up. The S&P PMI survey began the year with three straight expansionary readings after spending most of 2023 in contraction territory. The ISM Manufacturing PMI survey looks bleaker, but even there, the leading new orders index rose slightly. The backdrop is a more moderate environment for manufacturing everywhere, with international shipping activity rising and consumer demand stabilizing across advanced economies.

Of these, a housing recovery seems to be the safest bet, and all you have to do is believe that interest rate cuts will help as much as interest rate increases have already hurt. This will be a major, albeit temporary, boost to cyclical growth. In contrast, productivity increases may be the most enduring story, but also the most difficult to predict. But from a market point of view, one does not need to believe any particular scenario. The market is not an economic predictor. It's a mixture of emotions. Five plausible stories of improved growth seem to be enough, at least for now. (Ethan Wu)

UK stock discount, replay

Yesterday I wrote about the UK equity discount and whether it really exists. The question is a tough one because value stocks, non-US stocks, and penny stocks are not in your favor at the moment, and UK stocks tend to be all three of those things. Is there an additional discount, on top of that, for the UK in particular? I can't understand why this would be the case, and comparing the fundamental figures for popular and cheap-looking UK stocks with their rough US counterparts, the discounts seem broadly justified. I can't find great UK stocks.

Edward Smith, co-chief investment officer at Rathbones Group, wrote to say that one of his colleagues, Oliver Jones, had done some statistical work on the subject and had found that there was a unique deduction in the UK. Jones found that British stocks have a price-to-earnings ratio discount of about a third compared to US stocks, and about half that amount relative to the rest of Europe. But given the sector composition, exposure to the UK economy, and relative to fundamentals (growth, profitability and leverage), the discount is a bit lower. The exit of US tech stocks Magnificent 7 didn't change things either. His plan:

Why did the discount continue? Jones's guess is that Brexit has hurt investor confidence, a theory that explains the fact that the discount first appeared in 2016:

The vote in favor of Brexit sparked years of uncertainty about the UK's relationship with the European Union. . .

There are two reasons for optimism on this front. . . Investors have downgraded UK stocks in a broad manner that does not reflect where any effects of Brexit are likely to land. The fact that global companies listed in the UK trade at the same discount as local companies suggests mispricing, which may be corrected over time. Second, there is now greater stability and political consensus around the broad parameters of the UK's relationship with the EU.

This is just a regression analysis, and may be wrong. But suppose it is true. I still have the same problem: Where are my trades?

Many readers have written to say that UK tobacco companies and banks are unreasonably discounting their US counterparts. I don't see it in tobacco:

The difference in returns here is staggering, and there is a difference in leverage as well. Give me Altria on British American Tobacco all day. For banks, the situation (as always) is more complicated. Barclays and Citigroup is an interesting comparison. Both are large banks with large card operations and second-tier investment banking businesses, and both are about to turn the corner and become forever better. The basic numbers are also similar. Barclays seems a little cheaper to me; The only problem is that it's more leveraged, which muddies the return comparison:

What about banks that focus more on retail? Lloyd's and Wells Fargo make an interesting comparison, and once again Lloyd's is tempting. But it's not just an issue of leverage: Wells Fargo's growth numbers reflect the fact that regulators have prevented it from adding assets in recent years:

The only thing I found that was a legitimate deal was booze. Look at Diageo next to US alcohol group Brown-Forman. Diageo is significantly cheaper, with broadly similar growth and revenues that aren't a million miles away, with only slightly more leverage:

This is interesting, especially given the breadth of Diageo's brand portfolio. And I'm not just saying this because I've invested in Guinness, Tanqueray, and Bullet Ray.

One good read

Lena Khan's right-wing friends.

FT Podcast is not protected

Can't get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on previous editions of the newsletter here.