It is Not a Good Time to be Underweight US Market

08 Apr 2013 
SOURCE: Wong Sui Jau
Stock markets are off to a strong start in 2013’s first quarter. The best performing markets we tracked in 1st quarter all had double digits returns within one quarter alone. In Sing dollar terms, these were the Thailand market (SET index up 18.9%), the Indonesia market (Jakarta Composite index up 15.0%), and rather surprisingly, the US market (S&P 500 up 11.7%). It should also be worth noting that Japan followed very closely behind in 4th place, with the Nikkei index up 10.5% in SGD terms (the returns of the Japan market would have been even more, if not for the weakened Japanese yen against the Sing dollar).

The spotlight has firmly shifted to these two markets, US and Japan. It is significant, because these are two of the largest markets in terms of total market capitalisation, and an almost essential part of every global fund manager’s asset allocation. Yet, because of Japan’s multi-year underperformance, and also because there was a lot of pessimism regarding the US market as well, a lot of money on a global basis had shifted towards emerging markets, which were the engines of growth over the last few years.

Now, with the very strong performances in the first quarter by both the Japan and US Market, there will be some time where these monies flow back to home markets. Global fund managers need to rebalance their portfolios towards US or risk lagging behind benchmarks as well as their peers who were not underweight. Given the size of the US and Japan markets, such a shift is likely to mean that the markets of Asia excluding Japan may not see much traction in the short term. This is why the Asia excluding Japan index has only returned 0.9% in the 1st quarter, and the MSCI emerging market index has actually fallen by 0.4% in the same period.

While Asian markets continue to hold strong upside potential, many unit trust investors (as well as stock investors) here tend to drastically overweight Asian and the Singapore market, and are either significantly underweight in the US equity market, or may even be not invested in the US market. This is because many investors believe Asia has much stronger growth potential, and with most living here in Asia, there is also a tendency to be bias towards stock markets closer to home.

However, the US economy remains the largest economy in the world and its stock market is also the largest in the world in terms of market capitalisation. Many of the largest companies in the world, often leaders in their industries are all listed on the US stock exchange. These include leading internet companies and technology companies which are craving out their dominance on the internet and in the mobile space. The many problems which were highly published, such as the US fiscal cliff, how the republicans and democrats are always at loggerheads, how the US housing market collapsed after the financial crisis and how unemployment is still very high in the US made many investors very wary of investing any amount of money into US markets.

What some may fail to realise is that while the broad numbers with regards to the US does not look that great, corporate America has been doing extremely well of the last 12 quarters or so. It may shock some, but the earnings of the S&P 500 companies have grown by 22.3% since 2007, which was the last market peak. So, while we read about how the S&P 500 index and the Dow Jones has recently broken new all time highs, this was on the back of earnings which were significantly stronger than what they were like during the previous highs. In fact, earnings of the S&P 500 have been growing very steadily since 2008 till now.

In time to come, it will not just be the US stock markets breaking new all time highs. Other markets, including those in Asia, will also be experiencing the same, if they haven’t already. This actually should not be so surprising, and it may not necessarily be a cause for alarm. While they do go through cycles of bull and bear runs, each time a bull run comes, we often hit higher highs. This is because markets tend to trend upwards over the long term on the back of growing corporate earnings, which is the overriding objective of companies; to continue to grow their earnings continuously. Thus, they will strive to become more efficient, expand their market shares, invest into technology or buy up competitors or new businesses. While high unemployment rates in the US made investors worried, the flipside actually means that US companies are able to keep their salaries costs down since it is an employer’s market there.

When the market breaks new highs, there would be cause for concern if the market is trading at bullish valuations. But this is hardly the cause with the US market. The S&P 500 index is currently trading at 15.2 times historical 2012 earnings, while trading at 14.2 times estimated 2013 earnings. This compares to the 18.5 times earnings the market was trading at during the previous all time high in 2007. Thus, at least from a PE ratio valuation measure, there is much less to worry about the US market being in a bubble just because it has been breaking new highs.

Also, while the US has its own set of problems (some of which are not small ones), we should not forget that it has produces some of the most brilliant scientists as well as entrepreneurs the world has ever seen. It is also home to some of the largest companies is the world, and it has the most advanced and largest military in the world to protect its interests as well. So, I would never ever write off the US, and certainly, having some exposure to the US market makes a lot of sense. This is especially because many of these US companies are becoming increasingly global in nature, so their growth is not just limited or driven by growth in the US economy, but rather the global economy. So, if the emerging market economies grow by leaps and bounds, these US listed companies, which are already in these emerging economies, will benefit as well. I have been increasing my holdings in the US since last year, though this was a function of myself also being guilty of being overly underweight US. However, I urge all investors to seriously consider increasing their US exposure to a more normal allocation (Our recommended all equity portfolio have an allocation of 25% in the US market). As the 1st quarter so far has shown, even a developed market like the US market can also have its time in the limelight.

Message from Admin: The information contained in the above article represents the blogger’s personal views. The information is for general reading and should not be taken as financial advice.

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