ANTON ESER: Time to rethink how we weight US stocks in global portfolios

Over the past three decades US equities have offered investors fantastic returns. In that time they’ve provided real returns of 7.9% annually. And if you’d invested R100 in the S&P 500 in 2012, you would have come out with almost twice as much money than if you’d invested that same R100 in the JSE all share index.

These performance levels have naturally affected the approach of SA investors. Coupled with an underperforming JSE, it means more and more local money has been put into US equities. A good example is the high allocation given by retirement funds to global equities.

US equities now make up more than 60% of global equity portfolios. That means any movement in US equities has an outsize effect on global risk appetite and the global economy. For the past 30 years or so that weighting has made sense because of the returns on offer. But is it time to start rethinking it? Asking that question a couple of years ago would have been outrageous. Some fund managers would probably argue it still is. 

The companies that have played the biggest role in fuelling those returns have also been at the forefront of the biggest drivers of economic change. They’ve led the way in US dominance of the internet, technology and globalisation. It was a period of incredible innovation and US companies have ridden that innovation better than almost all others around the world.

But innovation isn’t the force behind their stock market performance. A look at US economic data over the past three decades shows where to start looking instead. Since 1989 US top-line sales growth has been below 2%. It’s also worth mentioning that GDP growth in that time wasn’t stellar either.

There were just four years when economic growth was above 4%. Three of those were at the height of the dot-com bubble in the late 1990s and the fourth was in 2021, coming off a 2.8% contraction in 2020 at the height of the Covid-19 pandemic. On average, GDP growth has been at 2.5% in that time.

Instead, as much as 40% of earnings growth came from tax cuts and low interest rates. While we tend to associate lower interest rates with attempts to soften the blow of the 2008 global financial crisis, they started falling long before that.

In the 1990s and early 2000s US Federal Reserve (Fed) head Alan Greenspan pursued a policy of aggressively lowering interest rates in an attempt to fight deflation. These low interest rates not only made it cheaper for companies to borrow the money they needed to fuel growth and expansion, they also increased investors’ appetite for risk as they moved away from bonds and savings accounts.

Every year that drop in interest rates contributed to earnings growth. Throughout this period there were consistent tax cuts too. In fact, the effective corporate tax rate dropped from about 40% to just more than 15% at its lowest. With the additional cash from those tax cuts many companies bought back shares, inflating their valuations.

These tax cuts contributed to an annual increase in earnings, but those tailwinds couldn’t last forever. As inflation spiralled from 2022 onwards the Fed consistently raised interest rates. In the coming months the tax cuts put in place by then president Donald Trump are also set to expire and show no sign of being replaced.

Those headwinds are already starting to bite. It may not look like it, with the S&P 500 hitting record levels in early February. But most of its returns in recent years have been driven by just seven big tech companies referred to as the “Magnificent Seven” — Apple, Amazon, Alphabet, Nvidia, Meta, Microsoft and Tesla.

In 2023 their collective valuations increased 70%. Together, they represent almost a third of the total US equity market. Take them out of the equation and the S&P 500 grew just 6%. With this in mind we should expect earnings growth below 2% from here. Factoring in an incredibly high multiple and some kind of mean reversion, there is a high probability that we should plan for negative real returns in the US over the next 10 years.

Knowing that, where should investors turn for returns? One option is to simply look elsewhere. After all, most other equity markets offer fairer valuations of their listed companies. But that’s not enough on its own. We believe investors should take a more defensive approach and look for solid, dividend-paying equities that are trading at a fair price.

In addition, both local and global bonds are now providing us with the highest level of real yields we’ve seen in decades.

• Eser is chief investment officer at 10X Investments.