US age of austerity isn't all bad news
What does Congress's deal mean for UK investors in a week when global markets are in turmoil? asks Bruce Love
Sunday 07 August 2011
The sweeping package of legislation approved by Congress last week averted disaster and allowed the United States to start borrowing more money just hours before the country was set to default on its already hefty loan obligations. But what does all this mean for UK investors?
The main issue investors need to be aware of is that we are still feeling the effects of the credit crunch, said Adrian Lowcock, a senior investment adviser at Bestinvest. He said, "We are still paying the price and just because these events are happening in America doesn't mean the UK is out of the woods. The US is simply joining the list of countries needing to make austerity cuts."
Mr Lowcock believes that the age of austerity will last until the better part of the next decade and said investors need to bear that in mind.
Last week's legislation let the country pay its bills, but it is as yet unclear exactly how the US intends to deal with such a large deficit and what any austerity measures will mean for the market. To find the $1.2trn to $1.5trn in savings demanded by the bill, a 12-member joint congressional committee will be formed over the next two weeks, and will make its recommendation towards the end of November.
"The question for investors will be what happens with that committee and how it will come up with the extra savings needed to lower the deficit," said William Dinning, the head of investment strategy Aegon Asset Management.
For Mr Dinning, the best-case scenario is the committee will produce genuine spending reductions to meet the agreement put in place last week. "But if they don't, they will need to find cuts anyway," he said.
While Mr Dinning said it was always unlikely the US would default, many experts believe a downgrading of the country's credit rating is almost a certainty at some point in the not too distant future. Like the UK, the US has a AAA credit rating. A downgrading would potentially mean the cost of borrowing by the US government would increase. Such a downgrade would have had a large impact on pension funds, some of which can legally invest only in the sovereign bonds of countries with a AAA credit rating.
According to Anthony Doyle, the director of investment specialists at M&G Investments, this will mean UK pension funds would be forced to sell their treasuries and look elsewhere. "We have been concerned about the US debt situation for a long time and expect it to lose its AAA credit rating at some point. But we didn't think it would be poised to happen so soon," said Mr Doyle. His firm suggests looking at other AAA-rated "safe havens" such as Norwegian, Swedish or German government bonds, or UK gilts.
But some believe the outlook is not as bad as we have been led to believe. "A downgrade – albeit maybe just temporarily – by at least one of the credit rating agencies to AA+ is a significant probability," said Steve Walsh of Western Asset Management, a subsidiary of Legg Mason. "[But] overall, we believe markets have already been discounting the deteriorating fiscal outlook of the US government for some time and would not expect a meaningful or long-lasting impact on either US treasuries, credit markets or the US dollar."
Mr Walsh does not believe there will be any mass selling of US bonds. "A downgrade is more likely to lead to selling of lower-rated risk assets in order to maintain the average credit quality of the portfolios," he said. "It is more prudent to hold on to more liquid assets such as US treasuries and sell lower rated assets."
Overall, Mr Walsh said he did not expect a meaningful or long-lasting impact on either US treasuries, credit markets or the US dollar. But if you're not convinced, Mr Doyle said corporate bonds might be a good alternative for UK investors. "Corporate bonds still look attractive to us. Many US conglomerates are in fantastic health, with solid profits earned outside the US responsible debt management and cost cutting efforts," he said
For investors eyeing US equities, Mr Lowcock points out US companies are very different beasts to the US government and its current debt woes, citing that Apple Inc has more cash than the US government.
"US companies are robust and more flexible than the government. The American market still has the ability to perform, albeit not at the levels we are used to," he said.
Mr Dinning believes the market is focused on other things, such as a lack of growth in equities. He said, "Congress has reached an agreement and done enough for now but too much debt means not enough growth."
For those wishing to stay exposed to US equities, Mr Lowcock said tracker funds – exchange traded funds such as the iShares S&P 500 – are a good way to keep costs down. But he insists there will still be opportunities to be found through occasional peaks in performance. In particular, the technology sector, where he says US companies will remain dominant.
As for the US dollar, Mr Lowcock believes its ongoing weakness will make Asia Pacific a more compelling place to invest. "The dollar will be the world's reserve currency for decades to come. But as it starts to decline, Asian economies will become more and more attractive," he said. "Funds like Aberdeen's Asia Pacific fund will be best poised to take advantage of this downturn."
It seems the age of American austerity is just in its infancy. But with the downside comes some significant investment opportunities.
"The US debt ceiling has been a concern for some time and will remain so for the foreseeable future. Expect an eventual downgrade from the AAA credit rating. Corporate bonds are looking more attractive but don't discount American companies, which are still as competitive as ever. Cash is yielding nothing and the dollar is a terrible investment."
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