Shaky state of the US economy should make investors wary

Americans hold a great Federal holiday on Monday, July 4, commemorating their independence from Britain in 1776. It is usually a day for celebrations with fireworks and barbecues. Yet this year there seems little for them to cheer about.

The US economy currently looks like a curate’s egg – something bad that is called good out of politeness or timidity. The phrase was coined in 1895 by George du Maurier for a cartoon in Punch.

Investors on this side of the Atlanic have enormous sums committed through savings and pension funds in the US, often without realising their level of exposure.

The US economy has significantly failed to grow. Data as diverse as consumer confidence and employment to property prices and retail sales show a country in difficulty.

Manufacturing fell in May by more than any month since 1984 whilst orders have dropped, such as vehicle sales which are down 3.7 per cent – the first fall in 18 months. Unemployment has risen to 9.1 per cent.

There are 10m vacant homes of which 2.3m have arisen from foreclosure. Sales fell by 7,000 in May to stand at an annual rate of only 319,000. Like the UK, mortgage requirements have tightened and many are reluctant to take on the costs of a move.

Much of this stems from political uncertainty. Businessmen are afraid to commit new money when they are unsure if Barack Obama will impose new regulations and succeed with a second Presidential term. His health package means manufacturers of medical devices have to pay over 50 per cent tax.

Bankers have clients with US$2 trillion held in cash, losing value in real terms. Central bankers are nervous about what Federal Reserve Board Chairman Ben Bernanke will announce on pumping in further money – ‘quantitative funding’ – or other appropriate action at their meeting in August.

Republicans are in disarray as they search for a Presidential candidate but still want government cuts in order to vote for increasing the level of debt. They are encouraged by the fact that no president since Roosevelt has been re-elected when unemployment was above 7.2 per cent.

Yet Obama has out-footed his opponents by planning an end to tax breaks for the rich and announcing a deficit reduction scheme.

The Federal Reserve forecasts the US economy will expand 2.7 to 2.9 per cent this year, down from its April estimate of 3.1-3.3 per cent growth. Citigroup expects 2.5 per cent.

The US is pursuing a vastly different economic policy to the UK. Here the government is cutting spending and raising taxes. The US is attempting to drive the economy by increasing government spending and reducing taxes.

Peter Heckingbottom, chartered financial planner and investment director at Leeds-based Pearson Jones believes “prudent investors should ensure they have exposure to both markets” although noting that US stock markets have underperformed the UK by about 15 per cent in the 12 months to June.

He says it is notoriously difficult to consistently outperform the index of the largest US companies (S&P 500) and favours Neptune’s US Opportunities fund, managed by Felix Wintle.

The same fund – as well as L&G US Index – are tipped by Andi Murphy, senior financial adviser at AWD Chase de Vere in Leeds. They were overweight in the US at the start of the year and felt that an extra US$600bn liquidity would provide a boost for US stocks.

Murphy says that with US authorities remaining supportive and stronger corporate earnings likely, they remain confident that stocks will “perform well in the medium term” and maintain an overweight position for clients.

Technology funds is the route recommended by Tony Fisher of Harrogate-based Ellis Bates “as it is the centre for much innovation in this field” although he cautions that investing in the US carries a currency risk.

If the S&P 500 is required, Fisher suggests accessing it by tracker funds or exchange traded funds.

Small and mid-cap funds have performed best over three and 10 years, up 39 and 44.3 per cent by comparison with 20.9 and 2.1 per cent for the general North American sector. According to Lipper research for the Yorkshire Post, the top performers over three years to end of May are:

n JP Morgan US Small Cap Growth A Dist, up 52.5 per cent;

n F&C US Smaller Companies A, up 52.4 per cent;

n TRP Funds SICAV – US Smaller Companies equity A, up 51.6 per cent.

Yet there are poor performers with almost 20 per cent loss from Focused Fund’s Equity USA, 8.9 per cent fall from Legg Mason US Equity A and 8.2 per cent loss with SGAM’s Equities US Focused fund.

Over a decade, the stars are Schroder US Smaller Companies A (up 103.3 per cent), Schroder ISF US Smaller Companies A (up 91 per cent) and Parvest Equity USA Small Cap C (up 78.3 per cent).

Despite the US deficit now around 10 per cent (akin to Greece), Martin Payne, director at Leeds-based stockbrokers Brewin Dolphin, says: “The US is home to some of the largest global branded companies in the world and these should provide good returns to shareholders over the longer term.”

In investment trusts, Payne tips both JP Morgan American (£380m run with a large cap bias and out-performing the S&P 500 over three and five years) and F&C US Smaller Companies (which targets firms with $100m-$3bn assets).

In unit trusts and OEICs, Payne likes JP Morgan US Equity Income (currently yielding 2.4 per cent pa), GLG American Growth (highly diversified with 250 stocks) and Threadneedle American Select (£1.2bn fund with a capital growth objective).

One way to reduce volatility is to subscribe on a monthly basis. As an example, the Edinburgh US Tracker, run by Aberdeen Asset, accepts monthly sums from £100 which can be placed in an ISA for tax-efficiency.

Launched in 1997, the fund has attracted over £215m, placing most emphasis on the IT, financial, energy and health care sectors.

If a collective with a lower but still significant US holding appeals, look at the Scottish Investment Trust which has 23 per cent invested there.

Three of its top 10 holdings are American: Apple, McDonald’s and Chevron, covering the technology, consumer and oil/gas sectors respectively.