Some of our readers might be familiar with the movie ‘Groundhog Day’, in which weatherman Phil (played by Bill Murray) lives the same day over and over again. For those of us in the investment world, this feels somewhat analogous to the movements in the S&P 500 Index, which goes up-and-down, up-and-down…, but has basically stood still on a year-to-date basis. (See Fig: 1)
We have long argued that US markets are trading above fair value and that European and Japanese markets offer far better value, which has been borne out by the massive outperformance of these markets (even in Dollar terms) during the year-to-date.
For the last six years, global equity portfolios needed to be overweight US to outperform the MSCI, but year-to-date this has not been the case and we think the underperformance of US markets will continue, particularly within the mega caps space. These global companies face the headwind of a stronger Dollar and, in the coming quarters, we will see the impact of this on earnings. Furthermore, the US Federal Reserve is at the start of a tightening cycle (the timing of which is still very much in the air) and liquidity is not going to be fuelling the market like it has for the last couple of years. Global growth is also constantly being downgraded, which will also make it more difficult for large US companies to generate strong revenue growth outside the US, especially given the strength of the aforementioned Dollar.
We are also concerned about the level of complacency in US shares and a comment by a well-known US trader recently caught my eye, stating that “In all of his years of trading, he had never seen such complacency in US markets, where investors are willing to recognize that the market might be overvalued in the short term, but at the same time no one seems to think it’s going to drop either.” That makes him and us very nervous.
Furthermore, legendary hedge fund manager, Stan Drunkenmiller, recently sounded the alarm bells, arguing that he “(H)ad an uneasy feeling about the market and that 2015 feels a lot like 2007. Whilst he wasn’t quite ready to short the markets, he was very uncomfortable having too much invested, especially in the US.”
Our House View, given the present risks out there, is to have protection in our portfolios. We have achieved this by investing in funds that are long volatility, particularly in the currency markets, and by diversifying our equity portfolios into Japanese and European equities.