Schroders: High stock valuations are a ‘red flag’

Schroders’ US small- and mid-cap manager Jenny Jones has voiced caution on the strength of the rally in her area of the market.

Her £962.7m Schroder US Mid Cap fund has gained 31.8 per cent in the past 12 months according to FE Analytics, while the Russell 2500 mid-cap index has risen 36.5 per cent and the S&P 500 large-cap index has increased 28.9 per cent. Ms Jones, speaking at a Schroders conference, said valuations were higher than long-term averages on several measures.

“Valuations are getting very high,” the manager said. “But this can last a long time. It is a red flag for me, though.

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“Markets are as high as they are because investors don’t see a lot of inflation. They are much more concerned about wages. That’s the area that could be problematic.”

As a result of the market movements Ms Jones has increased the fund’s weighting to companies she describes as “steady eddies”, usually defensive businesses that can maintain strong performance and relative outperformance. At the same time she has reduced exposure to “mispriced growth” holdings.

But Ms Jones’ colleague Joanna Shatney, head of large-cap US equities and manager of the US Alpha Plus fund, argued that investors were “willing to pay for” the consistency of US stocks.

“It is hard to find a bearish investor in the US but that doesn’t mean people are becoming complacent,” Ms Shatney said. “There is significant room for expansion from here. If companies are making money in a low-growth environment, they will just be able to leverage that going forward.”

However, both managers agreed that mergers and acquisitions (M&A) were likely to be key to the next phase of the US market cycle, with Ms Shatney saying shareholder activism will drive M&A.

“Buybacks have been a big driver this year,” the manager said. “The collapse of Lehman Brothers and the liquidity crisis are still fresh in people’s minds – that is what is delaying capital expenditure and M&A. Shareholder activism is going to change that, [though].”

Ms Jones claimed companies “are going to have to do M&A to grow”.

She added: “Companies are reticent right now to spend money on acquisitions, [but] I would expect M&A to pick up. A lot of companies are buying back stock and increasing dividends. I would expect, as comfort levels get higher, there will be more support for M&A.”

According to research by the Financial Times M&A activity in the US increased 7 per cent year on year in the period between January 1 and September 25 2013.

Ms Shatney’s Schroder US Alpha Plus fund, launched in December 2011, has gained 43.1 per cent since its inception. This is broadly in line with the IMA North American sector average and marginally lower than the 45.5 per cent rise in the S&P 500 index.

In the five years to November 27, Ms Jones’s US Mid Cap fund ranked in the second quartile of the IMA North American sector, with a 116.1 per cent return.