Long-term US and UK debt issues overshadow short-term concerns

As pundits fret about the global consequences of a possible near-term US economic recession, it’s worth examining exactly how the country has achieved growth in recent years, and whether a serious US downturn is really on the cards.

In fact, Aberdeen Asset Managers believes it is largely credit-fuelled consumer spending and high levels of government spending that have enabled the US - and indeed the UK - to grow. By living well beyond their means, these countries have run up unsustainable consumer and government deficits.

An over-emphasis on property as an investment has played a large part in inflating perceptions of personal wealth in these countries and encouraging unsustainable personal borrowing rates. Spiralling property inflation has boosted both consumer borrowing power and confidence to unrealistic and unsustainable levels, distorting the true picture of these nations’ economic health.

Meanwhile, investors and financial markets have also become pre-occupied with housing market sentiment as a means of assessing the wellbeing of the US and UK economies. Numerous commentators have lately predicted a severe US economic recession based mainly on a slowing housing market, despite the fact that consumer confidence levels are holding up, wage levels are buoyant and corporate earnings growth is healthy.

Undoubtedly, US GDP growth is slowing down, but we are far less downbeat about the immediate future of the US economy than many commentators are. Undeniably, house price inflation has slowed in the US recently, but the fact that the US and UK economies have mirrored one another over the last two years is a source of comfort. During the UK’s most recent experience of a property downturn in 2005, consumer confidence did not suffer too badly.

Aberdeen believes that because of their high levels of debt, the US and UK are likely to experience protracted economic downturns within the next twenty years, accompanied by negative effects on asset quality, corporate profits and dividends. At current levels, neither the US nor UK equity markets reflect the risks associated with this long-term scenario, and from an investment viewpoint, both look relatively unattractive. In contrast, Asia and emerging markets, where consumers and countries are free of punitive debt mountains, and populations are ageing less quickly, are more attractive. That said, Asian stockmarkets have enjoyed phenomenal growth in recent years and given the slowdown in the US returns are unlikely to be as strong going forward. Meanwhile, Aberdeen is also encouraged by the continued strengthening of both the European and Japanese economies.

Away from equity markets, real bond yields are likely to remain low by historical standards indicating little value, albeit returns may be slightly better than in 2006. Corporate bonds may not underperform but specific issues will continue to suffer from event risk.

Mike Turner, Head of Global Strategy & Asset Allocation, commented: “Global growth next year should be better balanced with the strengthening European and Japanese economies offsetting the slowing US economy. The US is not yet in dire straits but, like the UK, it faces some long-term problems caused by high levels of personal and government debt.

“While our long-term view of the US and the UK is clouded by these issues, our near-term view on global equity markets is moderately positive. Although we don’t exclude the possibility of a correction, we don’t expect a bear market in the near future either. Asia and emerging markets should continue to offer good returns, albeit they are unlikely to be as strong as in recent years. There are also an increasing number of exciting opportunities amongst European and Japanese companies.

“Recent weaker US economic data has prompted the dollar to break out of well-defined ranges. With support unlikely to come from interest rate hikes we expect the downside momentum to continue and current account deficit problems will again come to the fore.”