Perfect storm: Are US equities heading for a sell-off?

 
Annabelle Williams
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US equities seem like they could be headed for a correction

US equities have been on a six-year bull run and the seemingly unstoppable S&P 500 has repeatedly hit new highs. It reached a record level of 2,408 on 10 April this year, giving investors who bought the market a return of 183 per cent over the last six years.

The economy has continued to recover and datapoints analysing everything from job creation to the consumer are becoming more positive.

CORRECTION LOOMING

While the S&P 500 has dipped slightly since its peak, it continues to trade around record highs. But with interest rate rises on the horizon – known as policy “tightening” ­– some fund managers believe a sharp drop in equity prices is on the horizon.

“Investors are perhaps being too sanguine about the risks to US equities from the withdrawal of this liquidity and the increase in the cost of capital,” says Jason Hollands of Tilney Bestinvest.

For those who hold this view, the trouble with the S&P 500’s rise is that it has been more to do with QE money printing programmes and interest rates at historic lows than the fundamental investment-worthiness of US companies.

PERFECT STORM

Now stock prices look very expensive relative to their potential for growth. Investors buying US shares are getting less for their money.

Now that the liquidity tap of QE has been turned off, interest rates are expected to rise in December this year and stock prices look expensive, US equities seem like they could be headed for a correction.

“After six years of sharp rises, the US equity market has become expensive and increasingly vulnerable to a sell-off,” Hollands explains.

Experts widely expect an interest rate rise in December of this year. But the Federal Open Markets Committee, which sets rates, is meeting three times this autumn, in September, October and December. Given that economic data in the States has painted a positive picture, some believe rates will be hiked twice this year.

“There may be two increases in rates this year rather than one... in September and again in December,” says Kully Samra of Charles Schwab. “We think there is a chance we could get a correction... we have gone a very long time without one.”

At the moment, data shows there are not a high number of investors hoping to make money from betting the market will fall. Short interest – which reflects how many US stocks are currently out on loan and could be used for shorting the market – is within average levels for the last decade. The median short interest on a US stock is at 1.5 per cent, according to data analytics provider OTAS Technologies. It will be interesting to see if this figure changes as interest rate rises near.

HOLDING CASH

However, many fund managers have raised cash in their portfolios to higher than average levels recently. Choosing to sell some equities and hold cash instead is a way to lock in gains from the stock market and wait until better, cheaper opportunities arise. This is a safer approach than going short the market.

Hollands cautions against putting new money into US market-tracking passive products. “If you believe a market is expensive and vulnerable to a sell-off it’s the last type of investment you want to be putting new money into.”

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