Offshore investment: Hard to see where to go now
When the chips fall, in which market should investors put their money? The US, Europe or good old SA?
Investors contemplating putting money into offshore equity are confronted with tough decisions. Not least is whether to favour US or European markets.
When historical performances are considered, the choice is cut and dried: go overweight US shares. “All attempts so far to rotate out of US shares into European shares have failed,” says Philip Saunders, co-head of Investec Asset Management’s London-based multi-asset team.
Rotation out of the US into Europe was a very popular theme in 2016. “A lot of investors went underweight US equity last year and overweight European equity,” says Paul Hansen, director of retail investing at Stanlib.
They were in for a disappointment. European equity, reflected by the euro-denominated Euro Stoxx 50 index — which consists of the 50 biggest listed companies in 12 eurozone countries — turned in a rise of 4.7% in 2016. The comparable US Dow Jones index (30 companies) romped home with a gain of 13.4%.
US equity’s outperformance of European equity now stretches over nine years. In terms of the MSCI Europe and MSCI US indexes, both denominated in US dollars, US equity has outperformed European equity by 55% since late 2007, says Hansen.
The big question is: will 2017 be the 10th year US equity outperforms?
“US equity looks expensive compared with European equity,” says Saunders. “But it has been this way for several years. US equity has outperformed because of stronger earnings growth and aggressive share buybacks by corporates.”
But there are reasons for caution about the sustainability of US equity’s winning streak. One is a widely followed indicator best known as the Shiller p:e ratio. Developed by Yale University economics professor Robert Shiller, the Shiller p:e’s goal is to eliminate the influence of profit cyclicality by using share price divided by the average of 10 years of inflation-adjusted earnings to calculate the p:e ratio.
The Shiller p:e for the US S&P 500 index is at 28.7, a level exceeded only twice. The first was just before the 1929 Wall Street crash, when it hit 32.6. The second was in 1999, when it peaked at 44.2 just prior to the bursting of the dot-com bubble. A high Shiller p:e well above its long-term mean of 16.2 indicates an expensive market, but it does not mean that it cannot become even more expensive.
The Dow Jones index exceeded the 20,000 level for the first time ever last week. The record came just five days after Donald Trump’s inauguration as US president and brought the Dow’s rise to 12.5% since he won the presidential election in November. Clearly, the market likes Trump, or at least his bold promises.
“If Trump follows through on many of his promises it should have a big positive effect on US equity,” says Douw Steenkamp, global portfolio manager at Denker Capital.
For US equity, one of the key promises is the undertaking to slash tax rates for individuals and companies. “Middle-income Americans will receive a [huge] tax reduction,” promised Trump during his election campaign. Corporates are also in store for a big tax fall — from 35% to 15% — if Trump has his way.
Trump’s victory has been greeted by big jumps in key confidence indicators. Among them is the increase in the consumer confidence index. It soared from 109.4 in November to 113.7 in December 2016. “This is the highest level of US consumer confidence since before the global financial market crisis,” says Stanlib chief economist Kevin Lings.
First Avenue Investment Management’s chief investment officer Hlelo Giyose does not dispute that US equity can rise further, with the sudden flood of positive news. But in a market “running on the momentum of greed” he urges investors to tread warily.
“There is no bell that rings when the market is at a peak,” says Giyose. “But the warning signs are there that the US equity market is in the final phase of a bull market that began in [March] 2009.” Among key warning signals is that the US economy is nearing full employment, says Giyose. It portends faster-rising wages and inflation pressure, which in turn will put upward pressure on interest rates.
“A period of rising inflation and rising interest rates is the most dangerous time to put money into an equity market,” warns Giyose.
Saunders also sees warning signals flashing, but does not advocate rushing out of US equity. “We are in the final innings of US outperformance,” he says. “You should sell into strength on a three-year view.”
Whether investors should switch into European equity is another issue. On a valuation basis Giyose believes the eurozone has an edge over the US.
So too does Russell Investments, a US firm with US$244bn assets under management. “We have an underweight preference for US equity in global portfolios, primarily on the back of their expensive valuations,” states the firm in its 2017 outlook.
Russell Investments comes out in favour of the eurozone over the US, noting: “Eurozone equities are slightly cheap in an absolute sense and outright cheap relative to the US.”
Steenkamp is unconvinced. “We struggle to see [broad] value in eurozone equity, but there are individual companies that are cheap,” he says. The eurozone also still faces “huge political uncertainty”, says Steenkamp. This relates to, among other things, the outcomes of elections in four major eurozone countries in 2017: Germany, France, the Netherlands and Italy.
Goldman Sachs agrees, cautioning that the biggest downside risk for eurozone equity this year is political uncertainty.
Steenkamp believes better value is to be had in UK equity. “UK equity was derated significantly following the Brexit vote,” he says. “Our view is that the market is overpessimistic about the UK.”
Whether it is wise to have a heavy offshore exposure right now is also debatable. It was not wise in 2016, when the rand’s 13.2% rise against the US dollar trampled on any foreign gains.
Global currency uncertainty is also a key concern in 2017.
Ominously, the Bank of England’s markets directorate head Chris Salmon has warned of more “flash crashes”, such as when the pound fell 6% in minutes on October 7.
Cautious investors cannot be blamed for wondering whether keeping their money in SA this year again is not a bad idea.