ANTON ESER: Time to rethink portfolios as lost decade on the cards for US equities

The first rule in investing is, don’t bet against US markets.

For as long as I’ve been in this industry, US equities have been the gold standard of global investing. Over the past four decades, they have delivered returns so extraordinary that even seasoned investors would occasionally pinch themselves.       

Just this year, US stocks climbed another 25%, continuing a trend that has brought an annualised return of 15% over the past decade. For SA investors, with our increasing offshore limits — now up to 45% since 2022 — this has been a gift. Many balanced funds have about 30% allocated to the S&P 500. 

But the US stock market has now vaulted into uncharted territory, surpassing a staggering $60-trillion in total market capitalisation and now stands at 202% of US GDP, the highest ratio yet recorded. The American market isn’t just hot — it’s a roaring inferno. 

It’s been a spectacular ride. But history warns us that all good things eventually end. The numbers are now painting a sobering picture of a lost decade ahead for US equities.

Warren Buffett once said: “Price is what you pay; value is what you get.” The price investors are paying for US equities is astronomical. The S&P 500’s cyclically adjusted price-to-earnings (CAPE) ratio now sits above 38 — territory we last saw during the dot-com bubble in 2000. When valuations have reached these levels in the past, the market has never delivered positive returns over the next five years.

Since the 1980s, when corporate borrowing costs hovered at about 15%, we have seen a remarkable, decades-long decline in rates. This falling cost of capital was a tailwind for corporate profits. But that era is over. Rates have risen, and companies must now finance debt at higher costs, becoming a headwind for earnings growth.

Over the past two decades, US government debt has ballooned to 120% of GDP, fuelled largely by corporate tax cuts under Reagan, Bush and Trump. These cuts transferred trillions from government coffers to shareholders, boosting after-tax profits. But this came at a cost: deficits are now running at unsustainable levels. Fitch Ratings downgraded the US last year, citing concerns over debt sustainability as interest payments climb towards 12% of government revenue. 

This trio of tailwinds — valuations, declining interest rates and short-sighted fiscal policies — have been responsible for at least 40% of US equity returns over the past 35 years. It is potentially far higher when factoring in the contribution to economic growth, corporate sales and consumer incomes from large government deficits. As these tailwinds reverse, so too will the returns investors have grown accustomed to.     

Outside the US 

It is time to think differently. The good news is that the investment landscape outside the US is far more promising. SA for one offers a compelling long-term opportunity. With high dividend yields and conservative earnings growth projections, local equities could deliver real returns of about 7%. If the pace of structural reform accelerates, those returns could easily exceed 10%. 

Between 1998 and 2010, SA equities outperformed global peers by a staggering 16.7% a year. Starting valuations were key to that outperformance — a lesson investors would do well to remember. 

The investment world is shifting. For decades, US equities carried portfolios on their back, supported by falling interest rates, lower taxes and fiscal largesse. But those pillars are looking shaky. As investors, we must adjust to this new reality by diversifying our portfolios, focusing on undervalued or fairly priced markets and incorporating defensive assets such as inflation-linked bonds to hedge against uncertainty. 

Managing a portfolio is not about chasing the winners of the past. For a long-term investor it is not stories or the daily noise of markets that is important, it is about the numbers. Forecasting events and timing market moves is best left to the talking heads. Through that lens the next decade may look very different from the most recent one — let’s make sure we’re ready for it. 

• Eser is CIO at 10X Investments.