The Weekly: The US – a hole in one or double bogey


Unlike the US Ryder Cup team, the performance of the US stock market has been nothing short of spectacular.  It’s ten years since the height of the Financial Crisis, and since then markets -particularly in the US - have been on the longest bull run in history. On a GBP total return basis, the S&P 500 is up almost 300%, while the Dow Jones Industrial Average is up 305% over the last ten years. It makes the UK’s 115% return look moderately feeble. (Source: FE Analytics 2018) 

Many UK based investors are currently avoiding US markets, especially when they are pushing new highs, but we believe this is the wrong approach. The fact of the matter is the US remains the foremost dynamic and enterprising economy in the world. It’s true that not many US focused fund managers manage to outperform the US indices, and this is inherently the problem with the most over analysed (efficient) market in the world, it leaves it more difficult to identify opportunities. By looking at the performance of the IA North American sector; this is the collective performance metric for funds that invest in North America; US focused funds have underperformed both the Dow Jones and the S&P by 50%.

Source: FE Analytics 2018

This does not necessarily mean there are no US focused funds that don’t outperform the main US indices, but it does illustrate the tough time that fund managers are having in this sector. It is very difficult to justify management fees on a fund which lags behind its benchmark. Conversely, the IA UK Equity Income Sector have outperformed the FTSE 100, thus indicating that the majority of UK equity Income funds have been outperforming their benchmark.

Nevertheless, this isn’t an excuse for investors to avoid the US, or worse for stockbrokers and advisors to avoid the US market or reduce asset allocation. Just because it is widely believed that the US market is overvalued, it shouldn’t mean reducing or, even worse, removing exposure from the US completely. There is another question that also needs to be asked; US markets have been in their longest bull run in history but are they overvalued? There is no doubt that it is one of the more expensive markets, and despite being one the most efficient market there are still basket cases in the US; one such example that we have picked up on previously is Tesla. It produces a fraction of the cars that Ford does, yet it is valued higher having never made a profit. Over the weekend it was announced that its charismatic boss, Elon Musk, resigned his position as Chairman, however he will continue in the position of CEO. The FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks are also partly responsible for distorting the view that the US market is overvalued. For one, their share price does in no way reflect earnings, whereas on the whole US corporate earnings have been soaring. Since the inauguration of Donald Trump US share prices have increased 25%, but earnings have increased by as much as 20%, in part to the tax reforms that Mr Trump introduced. With prices and earnings growing on an almost one for one basis the augment can be made that the US stock market is behaving sensibly. Nevertheless, the cyclically adjusted price to earnings ratio (CAPE) doesn’t lie, and it is the best measure to assess whether the market is overvalued. The CAPE ratio is currently 31, the highest it has been since the dot-com bubble burst at the start of the millennium. So yes, it is a pricey market, but like any financial ratio it must be taken with a pinch of salt.

Currency has also played its part as to why many are currently underexposed to the US. Over the last five years Sterling is 25% weaker when compared to the US dollar. Most of this weakness in Sterling was in the immediate aftermath of the Brexit referendum and, thus consequently, there was some profit taking from Sterling investors exposed to the US. Pray there should there be any clarity on Brexit, then we should see an increase in the value of Sterling compared to the US dollar. Even if the US market continues to rise, any Sterling investor could lose out as the price of Sterling rises against the dollar. It is easy to see how currency can impact performance on the graph below when comparing the same North American fund, albeit one is hedged back to GBP. Even though both funds invest in the same underlying securities the unhedged fund has outperformed the hedged fund by over 40% as Sterling has weakened over this period.

Source: FE Analytics 2018

Any investor wishing to mitigate any future rise in sterling against the dollar may want to switch from the unhedged fund to hedged fund. This ensures exposure to US markets while removing currency risk. 

From reading this you might think we are bullish on the US and that it will continue to outperform other markets. The truth is we don’t know, but this is missing the point. We do not necessarily advocate increasing exposure in the US, but what we would advocate is for UK investors to maintain some exposure to US markets. Furthermore, it is often overlooked that as the US economy is the largest in the world, anything that spooks the US market is also likely to spook the rest of the world. By avoiding the US investors are not avoiding US financial contagion. 

Fed raises rates and hints at fourth December rise

Following strong gains in prior weeks, equity markets paused for breath last week as investors waited on the Federal Reserve’s latest policy meeting. The S&P 500 lost -0.5% whilst a bounding oil price helped the FTSE 100 close the week in positive territory with a +0.3% gain.

Wednesday saw the Federal Reserve raise interest rates by 25 basis points, as expected by most market participants. This is the third raise this year and US base rates now stand at 2.00%-2.25%. The Fed still expects one further move this year in December, all being well, and whilst there is some difference of opinion within the committee’s forecasts, the consensus would suggest three rises are due in 2019. The Committee also acknowledged the current strength of the US economy and increased its own economic growth forecasts for this year and next, to 3.1% and 2.5% year-on-year respectively.  The US Dollar appreciated against most major currencies; climbing +0.4% against Sterling and +1.2% against the Euro over the course of the week.

Most other major equity markets succumbed to modest losses. European markets were mixed following some slightly weaker inflation data released midweek; Germany’s DAX 30 finished -1.5% lower whilst the French CAC 40 closed the week flat.  Italy’s coalition government agreed to a wider-than-expected 2019 budget deficit goal of 2.4%, triple what the previous government had planned, which led to some selling pressure on equity markets late in the week. 

Japanese stocks posted solid gains during a holiday-shortened trading week; the Nikkei 225 was among the best weekly performers, returning +1.1%, and now stands just short of its 2018 high.

The price of oil played a large part in supporting the FTSE 100 index which has a large constituent of commodity stocks. Brent crude oil rose +5.0% to just under $83 per barrel at Friday’s close, taking wind from last weekend’s Organization of Petroleum Exporting Countries (OPEC) meeting where members agreed not to increase their oil production. Cuts to Iranian supply due to US sanctions and Venezuelan difficulties have played prominent roles in the oil price rise year-to-date.

The week ahead

The latest production indices are back in focus this week with the UK, the Eurozone and the US all releasing PMI data before the close of play on Wednesday. These follow on from China which released its own, mixed figures over the weekend which continued to show a deterioration in the Manufacturing sector, offset but modest strength in Services output. However, the big data related news will arrive on Friday in the form of the US labour market report for September. The economy is forecast to have added 185,000 new jobs over the month with the unemployment rate forecast to have declined by 10 basis points to just 3.8. Eurozone unemployment figures released this morning also showed a slight reduction in the headline rate which now stands at 8.1%. Further data from China is in short supply with Japanese activity also limited on this occasion. (Source: Forex Factory as at October 2018)

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