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Market View

Is the US equity market a victim of its own success?

 A PDF version of Market View is available.

US equities have been enjoying a prolonged purple patch, with trillions of dollars flooding into the S&P 500 (an index that is widely regarded as the best gauge of US company performance) over recent years. The US has outperformed most other equity markets since 2009, by properly addressing the issues created by the 2008 financial crisis allowing it to benefit from superior business performance, while the rest of the world failed to get its collective act together.

But times are changing. Prior to the financial crisis, US businesses made up around 50% of the MSCI World - an index that tracks the performance of the world’s leading businesses. At the start of this year, that figure stood at a remarkable 64%. Today, however, it has fallen back to 57%. This is not necessarily due to fears for the US economy, but more that US equities have become too expensive relative to other markets. Now that other global economies are starting to recover, the investment momentum has shifted in their favour.

Over the last few years, the US offered a welcome source of reasonable growth and stability, attracting the lion’s share of investment flows and, consequently, inflating prices. As the economies in other regions (such as Europe, emerging markets and Japan), continue to come back to life, active fund managers are able to act upon new opportunities with increased confidence, and are allocating to these regions at the expense of the US.

Of course, we’re not writing off the US just yet. Trump’s agenda of tax cuts and de-regulation should support economic growth and therefore company earnings. Also, even if Trump fails to achieve any of his agenda points, we know that regulation and taxes aren’t going to get any worse. But much of this optimism is already reflected in share prices. Against this stable but expensive backdrop, investors are more comfortable with the global economic outlook.

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“With valuations high, an underweight position in US equities is becoming the consensus view. We have been well positioned for this rotation out of the US, as reflected by the strong performance our clients have enjoyed. We think there is still some room for this trend to continue.” Philip Smeaton, UK Chief Investment Officer

Why the rise in passive investing favours active investors

Passive investing has surged in popularity recently, attracting in the region of £2 billion of in-flows every day. This flow of capital means that anyone tracking the S&P 500, for example, would have experienced excellent returns over the last few years.

For active investors, this herd mentality brings opportunity. As valuations become stretched with large in-flows, there is a danger that the index will fall, creating a similarly self-reinforcing outflow. In the meantime, active managers can look elsewhere for hidden prospects at a more granular level, finding opportunities that are almost always missed by merely tracking an index.

Because passive strategies give little credence to the underlying strength of a particular business, so its intrinsic value can be under-appreciated. As active managers, we hope to deliver a return that truly represents our highest conviction ideas; taking this risk is the only way to deliver great performance.

Infrastructure funds – an alternative to bonds?

It’s safe to say that fixed income assets have been a difficult nut to crack in recent years, and the challenges look set to continue. Government bonds are expensive relative to their own history and they remain vulnerable to higher inflation and growth surprises. And while corporate bonds were offering some solace, the global hunt for yield has driven even these prices to expensive levels, making them less attractive.

As an alternative to bonds, infrastructure funds can offer predictable and reasonable returns over the medium term. They invest in companies that own and operate essential public assets such as roads, airports, rail, power lines and communication towers. These underlying assets are attractive because they offer:

  • High barriers to entry

  • Constant demand for services

  • Government backing

  • Predictable cash flows

  • Protection against rising inflation

We’re always looking for ways to meet the investment needs of our clients. In the absence of good returns on traditional fixed income assets, we would certainly look further afield to achieve some stable returns.

“Passive investing shifts the decision from choosing an individual stock to a decision about which asset class to be invested in. Like anything, the success of one over the other will be cyclical, and both will have their day in the sun. Right now, passive investing is in vogue. But as investors search for the best performing asset classes, driving up prices, active managers may have an opportunity to seek outperformance in other places.” Matthew Brittain, Investment Analyst

 A PDF version of Market View is available.

This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed above are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Reproduction of this commentary is not allowed in whole or in part without prior written agreement from ‘Sanlam Private Wealth. Past performance is not a reliable indicator of future results. Investing involves risk. The value of investments, and the income from them, may fall as well as rise.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.