Why the US Market is Still Compelling

Can you have too much of a good thing? When it comes to the US stock market the naysayers believe so. The S&P 500 has risen 125% over the past five years

Emma Wall 23 April, 2014 | 8:00
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Can you have too much of a good thing? When it comes to the US stock market the naysayers believe so. The S&P 500 has risen 125% over the past five years; through default threats, presidential elections, controversial political policies, oil and gas discoveries and QE tapering, the index just keeps climbing.

It is this stellar performance that has led many investors to believe the trajectory cannot continue at this pace. The law of investment gravity must kick in at some point after all; what comes up, must come down.

Recent disappointing economic data from the US seems to support this theory. Rounding up the swath of data across the pond Morningstar.com’s Bob Johnson said last week:

“The economic news this week was confusing. Just about every metric could be interpreted negatively or positively, depending on the time frame picked and the amount of detail work that one was willing to do. Industrial production, existing-home sales, and the consumer price index all had a good news-bad news feel. However, none of the metrics was anything close to booming, even in their most bullish interpretation.

“With the possible exception of the Affordable Care Act, there is nothing else big enough on the horizon that can really get the economy moving again. Again, I am not forecasting a disaster, just some caution for those overly bullish on the economy.”

Add to that the market skitters created by Federal Reserve chair Janet Yellen implying interest rates could be raised in as little as six months’ time, and you can understand why some investors may be considering taking profits and reducing exposure.

The beginning of this year has had a rather unusual backdrop however. The US experienced a once-in-a-lifetime weather event, with several feet of snow covering the continent. Even the usually mild southern states were blanketed with snow; disrupting corporates and consumers in equal measure.

“US growth has disappointed so far in 2014 – having dropped off from an annualised rate of around 3.5% at the end of last year to about 2% in February,” said chief economist for asset manager Neptune James Dowey.

“Data has been poor – not dramatically so, but more than a bull would want. Is this is a symptom of underlying economic weakness – possibly because the current cycle is now getting quite old? Or has the economy simply been as weak as we’d expect it to be given the extreme weather this January and February?”

By creating a measure of the weather called heating degree days, Dowey and his team found that the weather was negatively correlated with job growth across state; the economy suffered in the regions where the weather was worst. Lending further support to the theory, where weather had improved over the last month, these regions had begun to show economic growth once more.

“We found that it was totally feasible that bad economic data could be down to the weather. There has been geographical divergence over the last month as Florida and Texas begin to pick up,” he said.

Speaking in San Francisco at a conference last week, Dowey said that the economic data was actually supportive for the stock market – once you had put these snow days aside.

“As long as the Fed doesn’t adopt too hawkish a stance in response to such a rebound, nor allows the market’s expectations of rate hikes to run too far ahead you’d expect growth to rebound over the next few months and support the stock market,” he concluded.

Neptune US Opportunities manager Felix Wintle says he remains extremely bullish on the US. While it is not unusual for a manager to champion his own asset class, Wintle concedes that the themes have changed since the beginning of the rally – but the opportunities have not dwindled.

The Bronze Rated manager says smaller companies are outperforming large caps – and lower quality companies outperforming the high quality defensive stocks.

“Companies are feeling positive. In the past share buy backs have been the chosen avenue for companies to distribute their spare cash as they didn’t feel confident to go out and invest or expand. Now capital expenditure is beginning to come through, and mergers and acquisitions are picking up,” he said.

M&A activity has boosted the market. In the past only the share price of the target would see gains, but now the bidder’s share price is rising on rumours too.

Macro headwinds outside of the US have also dissipated; fears around Europe and China have lessened. The IPO market has also picked up – and is diversified across all sectors.

If all this sounds like too much good news, and the contrarian investor inside you is saying sell, Wintle has a word of rationale.

“In 2000, just before the tech bubble burst, the phone was ringing off the hook with requests to buy technology stocks. In 2008, all I would hear is ‘buy me commodities’ and that market has not since recovered. Investors now are not being faddy. There is little retail involvement.”

Wintle points to the bond market as an indicator of stability.

“To be bullish on equities you don’t have to be bearish on bonds,” he said. “The fixed income market looks stable and that’s often where cracks first appear.”

Back in London, away from the sun of San Francisco, the bears still growl on.

Ian Lance, manager of the RWC Enhanced Income Fund said that valuations were off the scale in developed markets – and not in a good way.

“Quantitative easing may have inflated the US stock market up until now, but there is no guarantee that continued stimulus – from either the US or Japan will have the same effect in the future. Earnings have flattened and prices have risen. Debt globally is higher than it was in 2007 before the global recession and the recovery has been anaemic despite all that stimulus.”

Still – a properly balanced portfolio contains differential strategies, and two views make a market. Perhaps savvy investors can allocate holdings to both bull and bear beliefs, and watch their portfolio roar. 

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Emma Wall  Emma Wall is Editor for Morningstar.co.uk

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