InvestmentsJul 20 2015

UK investors shun US equity markets

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UK investors in US equities may well have been distracted by recent short-term noise in the markets, as speculation over when the US Federal Reserve will make its first interest rate hike mounts.

Meanwhile, the technology-heavy Nasdaq index has been climbing to new highs, mainly on the back of healthcare and biotechnology deals.

Charles Schwab UK managing director Kully Samra notes: “Stocks have managed to creep into positive territory for the year, pushed along by somewhat better economic data, continued loose monetary policy by global central banks, and robust merger and acquisition [M&A] activity.”

Data from FE Analytics shows that the S&P 500 gained 16.08 per cent in the 12 months to July 1, while the Nasdaq OMX 100 – which is made up of the 100 largest firms listed on the Nasdaq – was up 25.66 per cent in the same period; a rise not to be sniffed at.

Mr Samra adds that data from Evercore ISI Research reveals there have been more than 1,000 M&As in the US in the past 16 months.

In spite of this M&A activity, he thinks the current environment in the country is distinctly “beige”.

He says: “The middle is where we seem to be stuck from a US market perspective – valuations are neither a screaming buy nor sell. Sentiment is relatively neutral, the Federal Reserve is in limbo and economic data is lukewarm.”

Clare Hart, manager of the JPM US Equity Income fund, says: “Talk to US companies and they will tell you that it’s not the hardest time in their history – such as in the dark period during and following the financial crisis – but things aren’t easy either.

“They are focused on generating organic growth, doing M&As and generally trying to grow their revenues. Expenses have already been squeezed to the bone and this is not the kind of market that just carries companies along on a tide of momentum.”

Nevertheless, she claims there is a solid basis for continued earnings growth among companies in the S&P 500 index, and predicts 4 per cent growth in earnings per share by the end of this year.

Mr Samra adds that stocks will “manage to grind higher in the next several months”, with a few bumps along the way.

“The possibility of a correction still exists, which although unpleasant, could help to break the market out of its ‘beige’ phase,” he says.

The latest figures from the Investment Association show US equity funds falling out of favour among UK investors, which suggests they remain unconvinced by the growth some managers and analysts are forecasting.

In May, North American equity funds – including the Smaller Companies sector – recorded a deficit in net retail sales of £56m, while the average net retail sales for the previous 12 months were an equally disappointing -£17m.

Nick Thompson, director of US equity strategies at Janus Capital, thinks investors are “taking money off the table” across equity markets, irrespective of the region.

He explains: “I think the money is either going back on to the sidelines to wait out the volatility, or some of it is going out of the US and into Europe where there’s a better liquidity backdrop, with the central bank injecting money there versus the central bank here not injecting money any more.”

Mr Thompson observes that much of the recent volatility in markets can be attributed to expectations around a US interest rate hike.

He adds: “I think what people need to realise is that equities can hold on to their multiple with a reasonable upward trend in interest rates. So this idea that there’s some point in time where the Federal Reserve suddenly decides to raise its rate and that’s the end of the game for equity markets isn’t really accurate.”

So where should investors in US equities be positioned?

As always, it’s a case of riding out any short-term distractions, such as predictions about when and how much the US interest rate will rise by, and focusing on the longer-term picture for US firms.

Mr Thompson adds: “What I would be doing is thinking about where you can find high-quality growth investments.

“We really believe this environment we’re going into will favour active management. Whereas I think we’ve been in an environment for the past five years that has favoured passive [investing].

“I do think the smart investor is going to hold on through these bouts of volatility because the general trend for good-quality companies will be upward.”

Ellie Duncan is deputy features editor at Investment Adviser