It’s not hard to see why short-term risks may be a priority for US equity investors. If uncertainties about the US Federal Reserve’s next moves haven’t been enough to cloud the outlook, there are bank failures and a looming political deadlock over the US debt ceiling to worry about.
But perhaps long-term risks to the relative outlook of US equities versus other markets should be more on investors’ radar.
“Valuations in the United States are much worse than elsewhere,” Bridgewater Associates co-chief investment officer Karen Karniol-Tambour said at the Milken Institute’s annual meeting in Los Angeles this week.
The manager of the world’s largest hedge fund has sketched a picture of US markets that have been the place to be, but not anymore. “Usually when companies win for that long, that’s discounted,” he added. “You had this long period where US technology, in particular, ate everything. It is now fully priced. Karniol-Tambour says it’s hard to have more US dominance in investment portfolios than what already exists.
US stocks currently account for just under half of global stock market capitalization, up from about a third in 2010, according to Absolute Strategy Research. It’s lower than during boom times like the dotcom bubble, but it’s not very comforting. And in recent months, other stock markets have outpaced the US. The S&P 500 is up 8% in six months, but the FTSE Eurofirst 300 is up nearly 25% in dollars and even Japanese blue chips are up 16%.
Yet US valuations remain strong. A long-term point of reference is the cyclically adjusted price/earnings ratio. This measure compares prices to the previous decade’s average earnings and is often cited by long-term focused investors as a key metric. For the US benchmark S&P 500, the current Cape Ratio is just under 29 compared to a long-term average closer to 17. The Financial Times reported it last month.
The higher the valuations already are, the harder it is to get higher returns. The long-term relationship between the Chief and performance implies annualized total returns of a meager 3-5% over the next decade, calculates Ian Harnett, co-founder and chief investment strategist of Absolute Strategy Research.
Considering likely dividend income, weaker or weaker numbers imply that the index is going nowhere. Harnett points out that there have been several periods where it took a decade – or more – for real returns to turn positive. “That’s not what people want to hear, but it shouldn’t come as a surprise by these high ratings,” he says.
For example, Harnett points out that it took 11 years for investors who bought US stocks in December 1974 to see their inflation-adjusted yields turn positive, and 13 years for those who buoyed the stock in the last gasp of the rally. of the dotcoms in August 2000 .
Equity investors with hopes aimed at the moon typically don’t care about currencies, but the dollar has the potential to be a major factor here. Its haven status is a huge help in attracting overseas funds to US stocks and bonds. Between March 2008 and September 2022, the dollar gained 60% against a basket of its peers, even rising during a US-caused financial crisis. Yet it’s down 4% this year since the turmoil first hit US regional banks in March.
“There was a vicious circle between the dollar, US assets and the economy,” said Julian Brigden, co-founder and head of research at MI2 Partners. “It’s been a virtuous cycle, now this could be a game changer.”
But the flip side — and there’s always one — of not wanting to put more money into working in the US is finding another big market with long-term potential. The eurozone is having a moment, for sure, with an unexpectedly buoyant economy and relief that Russia’s war with Ukraine isn’t hitting it harder.
However, diverting funds away from the US over the long term means being confident that yields in the eurozone will consistently outpace those in the US. This is a big demand from a region with a history of weak growth and fewer top performers like luxury goods maker LVMH, which just become The first European company to reach a market capitalization of 500 billion dollars.
There is also Asia and within it China. The recovery continues in those stock markets, but with a marked lack of enthusiasm from US investors particularly as geopolitical tensions escalate. “We’re having a lot of conversations with clients, but with the exception of a few large asset managers, most people think it’s not investable right now,” said a chief accountant at a major bank.
There weren’t many great suggestions for alternative destinations on offer at the Milken event, and not everyone enjoying the west coast sunshine agreed with Karniol-Tambour either. But the more headlines continue to signal weak banks and political wrangling over maturing debt, the more questions investors will – and should – be asking about the long-term outlook for their US holdings.
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