Most global investors remain underweight the US stock market, believing one or more of the following...
Most global investors remain underweight the US stock market, believing one or more of the following statements to be true. The US is a bubble economy driven by stock market gains; the stock market is grossly overvalued and about to crash; and US equities are less attractive given the improving global economy.
However, remember that consensus is usually wrong (Asian Miracle in 1997? Strong Euro in 1999?) and that markets usually climb a wall of worry. Far from being a bubble, our view is that the US economy is in the midst of a productivity revolution that is being driven by unprecedented investment in technology by US corporations.
We believe this productivity growth is sustainable, and will continue to fuel 3% to 4% growth in GDP and 1% to 2% inflation for the next few years. Given this environment of non-inflationary growth, we believe interest rates will remain stable next year.
Thanks to the productivity revolution and the prospects for better global growth, we anticipate S&P 500 earnings growth to be higher than expected for the next few years. Greater than 10% earnings growth per year for the next few years, coupled with low inflation and low interest rates suggest that valuations, while high, are justified and sustainable. Valuations are further supported by the fact the S&P 500 Index has a dramatically higher return on equity than in the past.
Instead of US equities being less attractive given the prospects for global growth, we believe US multinationals will be some of the major winners from improving overseas economies. It is often forgotten that 40% of the S&P 500's sales and earnings come from overseas. We expect US multinationals to continue to gain global market share, especially in the technology, finance and capital goods sectors.
Given our outlook for higher than expected earnings growth, we are focusing on those companies beyond the 'nifty-fifty' that are demonstrating accelerating profits growth at attractive valuations. Additionally we are increasing the portfolio's exposure to selected multinational companies with strong prospects for improving overseas earnings.
Our largest sector overweight positions remain in technology, finance and capital goods respectively, as we expect these sectors to benefit from global growth and stable interest rates next year. In the technology sector we are overweight such global powerhouses as Cisco, Texas Instruments and Sun Microsystems, as well as some lesser known names such as Comverse (telecommunications), Veritas (storage software) and Xilinx (semiconductors). We continue our focus on risk control, keeping the portfolio's projected tracking error within our targeted 3% to 5% range.
We do not believe that the US economy and stock market are a bubble. In 1988, at the top of the bubble in Japanese equities, Japan accounted for 48% of the world's stock market capitalisation, yet its constituent companies represented only 16% of the profits By comparison, the US today is 50% of the world's stock market capitalisation, but also accounts for 44% of the profits, according to research from Lehman Brothers. What bubble?
In conclusion, the long-term positive trends remain in place, despite the current negative sentiment. Higher than expected corporate earnings growth, coupled with stable inflation, interest rates and valuations, suggest the US equity market should continue to move higher during the next few years.
A major investment question for global investors is whether the US is a unique investment opportunity in its own right or a catalyst for change elsewhere.
Christopher Lees is investment manager at Baring Asset Management
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