As we embark on a new year, the United States is the brightest spot in the global economy. The U.S. recovery, now in its sixth year, has transitioned to a more robust phase, leading to our most positive outlook in almost 10 years.
U.S. strength is particularly impressive relative to other advanced economies, as the eurozone's growth is lagging and Japan is struggling to stimulate animal spirits and inflation. Even emerging economies, long presumed to guarantee higher growth rates relative to the United States, are facing challenges in recalibrating to a different world order. If we also take into account the increasing frequency and severity of geopolitical challenges around the world, the United States stands out as an island of stability and economic strength that clearly appeals to investors.
But make no mistake. The U.S. economy still faces challenges. While the private sector has slashed its debt-to-GDP ratio to 223% from 288% since 2009, the public sector has just begun what will be an extended deleveraging process. And while the labor market has been improving, our analysis indicates the United States still needs between 2.7 and 5.2 million jobs to reach full employment. In spite of this labor market slack, the
Federal Reserve is likely to begin normalizing interest rates in 2015, a potential source of volatility in markets. Moreover, the lethargic growth patterns in other developed economies and the strong U.S. dollar could create head winds for U.S.-based companies with global operations.
While these risks are notable, we believe they are far outweighed by the positive momentum in the U.S. economy. Household assets and wealth have reached new highs, with assets and net worth increasing by $26.4 trillion in the last 5½ years. Job growth also has accelerated, with nonfarm payrolls growing by over 200,000 jobs monthly from February to November 2014. The unemployment rate now stands at the 66-year average of 5.8%. We believe the continued improvement in the labor market will lead to further healing in housing, which is still 16% below its pre-crisis peak.
(More: From big rallies to fallen (bond) kings, we saw it all in 2014)
Additionally, the collapse in oil prices is a windfall for American households that are likely to save as much as $750 in 2015 on gasoline and heating oil if prices are sustained at current levels. This boost to disposable income could lift spending sufficiently to make 2015 a year in which job growth and wage gains could further rebuild the wealth of the middle class. A stronger middle class also would likely lead to stronger revenue growth for companies.
EQUITIES STAND OUT
Surveying the global equity markets, U.S. equities stand out as an advantaged asset class. Although valuations are higher than historic multiples, the underlying balance sheets and cash flows of U.S. companies are much more robust versus prior peaks.
We recognize that U.S. equity valuations are higher than many other markets, but we believe the superior fundamentals in the U.S. warrant a premium. Some may pause before allocating to U.S. equities, due to the outperformance of the past few years or to the fear of volatility from Fed tightening. However, we believe that active management can mitigate the point-of-entry risk by investing in companies that remain attractively valued even after the rally of recent years. Moreover, it is important to remember that the Fed is likely to begin normalizing rates only if the underlying economic conditions remain strong, a situation that bodes well for equities.
(More: Bears absent in stock market rally, raising some worries)
We believe an effective way of participating in U.S. equities is through concentrated strategies, which allow managers to invest in their best ideas and naturally lead to high active share portfolios. Many investors believe that concentrated strategies are inherently risky, but this is not necessarily the case. Properly balancing the trade-off between diversification and concentration is key in this regard. For example, by holding companies with divergent cash flow drivers in order to ensure that bets aren't made on any one theme or sector, a manager can mitigate some of the risk inherent in a concentrated portfolio.
We are optimistic that the operating backdrop for U.S. companies should continue to improve in 2015. Furthermore, we believe the market can rise from current levels given earnings growth driven by moderate revenue growth, strong expense controls, and disciplined capital management. In our view, the positive fundamentals of the U.S. market combined with a skilled asset manager, should make the choice of investing in U.S. equities an easy one.
Christopher Blake is a managing director at Lazard Asset Management and lead portfolio manager of the Lazard U.S. Equity Concentrated Portfolio (LEVIX) and the Lazard U.S. Strategic Equity Portfolio (LZUSX).
