The eight-year US equity bull market has time and again confounded its many detractors, helping US stocks remain among the top performers since the global financial crisis.
Yet US equities are highly valued by comparison with other markets – the current Case-Shiller price-to-earnings ratio of 29.8 is almost double its long-term average. And after three straight months of growth, last week’s jobs numbers reveal that the US economy may be starting to cool off, having created only 98,000 jobs in March.
Consequently, investors are now starting to ask whether the US is still the place to pursue growth potential and protect purchasing power. While the Dow Jones Industrial Average has fallen about 1 per cent from its all-time high set earlier this year, a growing chorus of market watchers is calling for an additional retreat. With this in mind, investors overexposed to US equities may wish to consider the following factors when reviewing their positions:
1. Trumponomics could provide limited lift
Although markets initially had high hopes of stimulative new policies from President Trump, the recent failure of his healthcare bill has curbed some of this enthusiasm.
Moreover, not all of Trump’s remaining proposals are measures that have historically been proven to boost the US economy. Tax reductions for corporations and the wealthy tend to offer only a small lift, while new infrastructure spending and tax cuts for lower-paid workers have been substantially positive economic multipliers only in the medium term.
2. Higher inflation + higher rates = An unpleasant surprise?
US inflationary pressures could build much faster than the market expects, especially considering that the economy is almost at full employment and wages may soon start to rise.
The US Federal Reserve is closely watching income and wage data – two data points that have historically been closely correlated. Depending on what it sees, the Fed could find itself “way behind the interest rate curve” and move more aggressively, which would be an unpleasant surprise for the market.
3. Trade could spell trouble for the US dollar
If Trump begins implementing protectionist trade policies, there could be negative implications for the US dollar. The same is true in the event of rising oil prices, an expansion of China’s “one belt, one road” initiative, or a failure of the Trans-Pacific Partnership. The imposition of a potential US border adjustment tax could also hurt corporate profits and economic competitiveness by further boosting the dollar.
4. Cost of servicing debt stands to rise
The level of indebtedness in the US and around the world is significant, and it has only been made affordable because of extremely generous monetary policies. Even with a doubling of the US debt level in recent years, the annual cost of servicing it has remained around $425bn. As interest rates move higher and the US government spends more to service its debt burden, Trump’s financial wiggle room could diminish.
5. Demographics heading in the wrong direction
Ageing populations are a challenge all over the world, and the US is no exception. Its economy could increasingly feel the drag of productive older workers leaving the workforce, replaced by a younger generation that is less well paid.
Moreover, by subjecting immigration to the whims of politics, America’s famously flexible workforce could become less of an economic advantage. Lower levels of immigration, a shrinking talent pool and reduced relocational flexibility will all take their toll.
6. Technology is doing less with more
Despite some populists’ assertions, it is job-killing technology not globalisation that hollowed out America’s jobs market. This trend is certain to grow as companies invest more in robotics and artificial intelligence.
In addition, the multiplier effects on growth of new technology and social media, where the US is a leader, are much smaller than those of previous industrial innovations – and much more disruptive to existing businesses. In the end, we may find that many high-tech innovations are better at creating vast wealth than vast employment.
In short, even in a world where low interest rates have inflated valuations almost across the board, the US equity market is expensive. Add to this the fact that the US dollar is overvalued by perhaps 20 per cent, and the question may be when – and not if – the US equity market will pull back before starting a new cycle. As the saying goes, follow the money: many US corporations are already buying attractively valued assets in Europe and Asia.
As investors begin a new financial year, they would do well to consider this carefully when reviewing their investment approaches in the coming months.