America Express

Story Highlights:

• We believe the robust, across-the-board gains seen the last couple years will give way to a widening dispersion of returns, with stock leaders and laggards more evident.
• One area we expect to do better on a relative basis this year is the US, where economic growth is accelerating faster than in most of the developed world.
• Additionally, the much-feared US debt likely won’t prove to be the major drag many fear on growth this year.
• Investors should focus on fundamentals to uncover those industries and firms likely to prosper if economic growth outpaces expectations.

We’ve forecasted this year to be one for selective stock pickers. We believe the robust, across-the-board gains seen the last couple years will give way to a widening dispersion of returns, with stock leaders and laggards more evident. Picking the right narrower categories—countries, industries, sub-industries, and stocks—should be key to portfolio outperformance in an otherwise middling year.

One area we expect to do better on a relative basis this year is the US. Yes—the country where the global financial crisis originated just over two years ago and now home to an often-maligned $14 trillion public debt. (Though net debt—debt the government doesn’t owe itself—is about $9.6 trillion.)

Recent headlines have focused on the downward revision to Q4 US GDP. Yet, data show US economic growth is accelerating faster than in most of the developed world—and faster than many would have predicted, boding well for American stocks relatively. In February, the ISM manufacturing index rose to its highest level since May 2004—itself the highest level since 1983. Key measures including orders, production, backlog, and employment all accelerated, underpinning future growth. Consumer spending—responsible for approximately 70% of GDP—notched gains for the seventh straight month in January.

Additionally, the Fed continues to engage in stimulus efforts while some central banks abroad are cutting back or even tightening. Though our feelings about the Fed’s QE2 are mixed, and we didn’t see a pressing need for it, in the near term it should at least provide a tailwind to stocks. What’s more, fiscal austerity measures like those undertaken by PIIGS and the UK could limit economic growth prospects there (or make investors nervous they will do so), possibly weighing on those stocks relative to the US. Of course, there are still weaker spots in the US economy, though none should hold back the broader economy, and overall current fundamentals skew to the positive.

But what about the massive US public debt and ongoing deficits? Much of the pervasive fears are likely already built into current stock prices. Debt is always a touchy subject, but a crucial consideration is: Can we afford it? Our debt interest payments as a percent of GDP remained under 3% in fiscal year 2010—a lower ratio than at any point during the 1980s and 1990s (perfectly fine times for the economy and capital markets) and not alarming. Debt likely won’t prove to be the major drag many fear on growth this year—for reasons we’ve written about recently and will continue to write about as this year wears on—easing some of those priced-in fears.

Though we expect the US to be among the global leaders both economically and in capital markets this year, investors shouldn’t just throw a dart at the S&P 500 (nor should they wholly ignore the non-US—ever!). Instead, investors should focus on firms and stock categories with strong fundamentals likely to put them on the right side of an overall middling market.