When measured by the time taken for US employment to normalise to pre-recession levels, the great recession of 2007 is the most prolonged since the Great Depression of the 1930’s. After 62 months since the US first entered recession, employment is still only 97.8% of its former self. The March 2015 non-farm payrolls suggested just 126,000 jobs were added month on month, a soft reading which caused many to question the strength of the US recovery, and some to speculate about QE4.
To put it into perspective, headline unemployment in the US is now 5.5% and trending lower after peaking at 10% in 2009; Australia now exceeds the US and the UK with a headline rate above 6% with unemployment intensifying as the second order effects of the commodity price fallout begin to take their toll. In today’s AFR it is estimated that over 1000 jobs are at risk due to the potential mothballing of Atlas Iron’s (ASX:AGO) mines, the first of the high cost iron ore dominoes to tumble.

Figure 1. Months Taken for Employment to Normalise Post Recession and Figure 2. US, UK and Australia Unemployment
Source: Datastream
Since the early 90’s the US has had 3 recessions, Australia just one. While it is an impressive statistic for our finance leaders to crow about, I find it is somewhat troubling when considering the outlook for Australia that we have managed to avoid recession for so long. In his highly recommended book Antifragile: Things That Gain From Disorder, Nassim Nicholas Taleb uses an analogy of the prevention of forest fires which describes how risks can accumulate in a system:
‘Small forest fires periodically cleanse the system of the most flammable material, so this does not have the opportunity to accumulate. Systematically preventing forest fires from taking place ‘to be safe’ makes the big ones much worse.’
With over 23 years since our last recession, Australia arguably has accumulated plenty of ‘flammable material’, evident in our prohibitively high cost of doing business, a generation of property investors who believe prices only rise (with the personal balance sheets to match), a lack of political leaders willing to make the hard yet necessary decisions and an investor base crowded in our highly economically sensitive banking oligopoly. The lessons learned following ‘small forest fires’, such as frugality, conservatism and ingenuity, which arguably work to build resilience in a population and reduce systemic risk, are becoming fewer and far between. It is these factors (and more) which have encouraged us to intensify our effort in offshore equity markets.
The lower price of oil continues to be a large stimulant for the US due to its position as a large net importer. This has caused headline CPI in the US to fall significantly and brings the merit of interest rate rises into question.

Figure 3. US Headline CPI and Contributions
Source. Datastream
We are interested in the lower price of oil due to its ability to stimulate the US consumer, which results in a transfer of earnings from the large integrated oil businesses to the consumer staples. The longer oil stays low, the larger the potential stimulus. Avoiding energy has been a good place to be so far in 2015, while the consumer discretionary and consumer staples sectors have advanced in anticipation of an improvement in consumer spending. As we can see in the chart on the right below, consumer spending has lagged disposable income growth which bodes well for a pick-up in the future.

Figure 4. Consumer Discretionary and Staples Relative to Energy and Figure 5. US Personal Income and Consumption
Source: Datastream
Another big factor influencing global markets is the appreciation of the US dollar. For US multinationals who earn a large portion of their earnings abroad, this has been an adverse change. A rising USD can have two effects on global businesses. The first and most obvious is the translation effect, which ensures foreign earnings are worth less in the US dollar terms.
The second is the impact to a business’s competitive position, as international peers become relatively cheaper which can lead to lower unit volume. When investing in US domiciled global leaders, currency risk is hard to avoid. While many businesses hedge the impact of currency on their earnings, this typically only protects for one year forward. We suggest focusing on businesses that sell unique products, which limits the risk to volumes from currency induced price competition. Apple iPhones, Google search advertising and McDonalds Big Mac’s are all unique products. Alternatives exist, but these companies are the only producers of those exact products, limiting the risk to volumes.
On the other side of the coin, the depreciating Australian dollar has provided a dual tailwind to domestic Australian exporters such as CSL, the first from an improved competitive position and the second from the translation of foreign earnings. However, this tailwind is not worth an infinite price, as investors in Domino’s Pizza (ASX:DMP) seemingly forget; DMP currently trades on a multiple of over 50 times next years earnings.

Figure 6. Forecast EPS and Growth Rate and Figure 7. Price Level and Forward PE
Source: Datastream
Current EPS expectations for the US market have reduced to $3.23, a retracement of 4.1% since the $3.37 peak recorded in November and down 0.8% year on year. The S&P500 has advanced 11.6% over the last year, which has pushed the forward PE of the market to 17.5 times, the long term average of the US market has been around 16.5 times.
With flat to negative earnings growth and an above average base level, we think returns from the US market will be hard to come by going forward. It would take a sharp improvement in earnings for our view to change materially. However, let’s not forget that the market is just an assortment of publicly traded businesses. It is the job of the active stock picker to select investments which are fundamentally more attractive and with better prospects than the average.