Is the American experience exceptional enough for Wall St?

Hamish McRae on how US bulls have got it wrong

IS US business really so exceptional? It is a crucial question because so much of the enthusiasm on Wall Street is founded on the assumption that something special has happened to American companies - that they have somehow made a step change in their efficiency, and that this superior performance will enable the economy to race onwards. A brief visit to the States last week has convinced me that something special has indeed been taking place in the US - but that it is not quite as special as Wall Street seems to think.

Anyone who works with the best large US corporations will be aware of the quality of management, the attention to detail, and sheer hard work of the people there. But to say that big US companies are very good and are becoming better is not just an impressionistic judgement: you can see it in the figures. Have a look at the graph on the left. It shows what has been happening to US productivity over the last 25 years, productivity both in manufacturing and for the non-farm business economy as a whole.

A couple of obvious points emerge. One is that since the early 1980s recession manufacturing productivity growth has put in an extremely solid performance. It ran at between 2 per cent and 6 per cent a year through most of the 1980s, remained positive through the early 1990s recession, and then pulled away right through the ensuing boom. It is an astonishing performance, all the more so since productivity in US manufacturing was already higher than anywhere else in the world at the start of the period. It is easy to improve productivity if you are coming from behind, but extremely difficult if you are already far ahead.

The other point is less impressive. If you look at manufacturing things are terrific, and when we think of large American companies we usually think of manufacturers. If you look at the whole economy, the performance is less wonderful. This is the flip side of the amazing ability of the US economy to create jobs: in the service sectors, productivity has not been rising fast, for companies have been tending to meet additional demand not by improving productivity but by taking on more people.

As with all figures, you should take this with a pinch of salt. I suspect that these general productivity numbers fail to take into account improvements in the quality of service that has taken place in the US. As anyone who visits the US regularly will have noticed, the quality of service continues to improve - but it is very hard to pin this down in the statistics.

Nevertheless, it is clearly much harder to increase productivity in service industries than in manufacturing, which is a problem since only about 18 per cent of US GDP is now generated by manufacturing. So you can have corporate exceptionalism co-existing alongside quite muted productivity growth in the economy as a whole.

Looking ahead, there are reasons to expect rather slower growth in the US economy this year - it grew at 4 per cent in 1997 and clearly cannot keep that sort of breathless rush going for ever. JP Morgan, which dug out these figures, believes growth this year will slow to trend and that, in the near term at least, a slowdown in productivity growth will take place too.

How might Wall Street react to this?

Well, I suppose you could say that Wall Street won't care too much. It has been driven by many other things: for example, the high liquidity of the savings institutions and pension funds, expectations of continued good earnings by large companies, by the fall in inflationary expectations and hence in bond yields, or simply the fact that looking round the world there are not many other attractive places to stick the money.

I would accept all that, but still argue that underpinning Wall Street is a sense of general self-confidence, of which confidence in American exceptionalism is an important constituent part. Some figures last week showed that consumer confidence is higher now than it has been for 30 years. Just think of that - ordinary Americans are more confident of their own prospects and life-styles than they have been for an entire generation. So, in a way, it is unsurprising that investor sentiment should also be close to record levels too.

That exuberance is charted on the right. There are now two investors buying a call option on US equities for every one buying a put. In other words, twice as many investors think Wall Street will go up as go down. This is close to the record high reached last year: pretty bullish stuff. Merrill Lynch, monitoring this measure of sentiment among others, thinks that prices could surprise on the downside. Certainly, a simple glance at that graph does suggest that this level of bullishness is not sustainable.

So what should we be looking for? I think the difficult thing for Americans in particular to come to terms with will be the possible co-existence of very good companies and a less strong stock market. In other words, it is possible to accept the story that US corporations have made a step change in their performance and have opened up an even bigger gap with those of Europe and Japan, but still believe that too much good news have been priced into the market.

The test will come when things do slow down. Will America Inc use the opportunity of the next slowdown to slim their own operations yet again and hence be able to continue to deliver improved profitability? That there will be a slowdown at some stage is not in doubt. Economies never move back to their trend growth and stick there: they tend to overshoot both on the upside and the down.

The last five years have been relatively easy, for US corporations have been able to increase productivity in a period of strong and sustained growth. The next five will inevitably be harder, for they will have to increase productivity through the next cyclical downturn. That can be done, but it will be a severe test for managers, many of whom will only dimly remember those days when buyers did not queue at the door, credit cards at the ready.