It’s tough to find an asset allocator with an overweight position in US assets. Most agree that the stock market is expensive, the political situation is precarious and the economy may be on the cusp of overheating. Inflation is moving higher and further interest rate rises are imminent. So why does the stock market keep moving higher?
US equities have continued their strong run since the start of the year, fuelled by Donald Trump’s tax increases However, equity market valuations look increasingly precarious and appear to anticipate strength in the next quarter’s earnings In the past few days, there have been signs that US indices are starting to wobble. According to MSCI, North American equities are up 4.57% since the start of the year (data to 17 January). This is more than the Far East, on a par with Japan, and materially ahead of Europe, where – in many cases – economic growth is just as high and stock market valuations far cheaper.
There are a number of possible reasons for this. First is that the US continues to make up a significant proportion of global indices and passive investors continue to be an important influence on markets. While active investors are nervous about valuations, passive investors are less sensitive and continue to push the US indices higher.
It may also be that the Dollar is taking much of the strain. Sterling recently hit post-Brexit highs against the greenback, and US stock market returns look far more lacklustre in sterling terms (2.46% against 7.89% for Europe). There are those who believe that as America’s power and influence on the world stage slowly recedes in favour of China, the Dollar will continue to decline.
It may also be that US equities are in the throws of a ‘last hurrah’. Bull markets tend to run on longer than most people expect and the US economic expansion may be mature, but it is still happening and may be prolonged by US tax cuts. Earnings for US companies are still improving, and – in many cases – justify the valuations.
However, there are signs that investors are finally pausing for thought. Volatility of US markets is increasing; there is increasing nervousness that markets have already anticipated any strong improvement in earnings this quarter.
Either way, there are vastly better opportunities elsewhere. Yes, the US bull market may limp on, but increasingly, the potential downside does not justify the potential upside. Fiscal stimulus may douse a little short-term fuel on the fire, but the petrol can is looking increasingly empty.