The Envestnet Edge, August 2015
In a “meh” market, look again at U.S. stocks
The first half of 2015 was remarkably uneventful for many markets, particularly U.S. stocks. This very meh-ness of the current U.S. equity market is one reason amongst several why investors might want to focus on U.S. stocks for the remainder of the year.
So here we are, more than halfway through the year, and although there has been no dearth of daily news, it’s been remarkably static for many investments, particularly U.S. equities. Some sectors – energy and commodities above all – have been spectacularly weak as the global economy continues to adjust to massive supply and demand shifts, especially lower demand from China. A few sectors, notably technology, have done quite well, with several technology indices up close to 10% year-to-date. But in aggregate, U.S equities have had one of their least volatile and least interesting six month periods in a very long while.
Some have taken to calling this a “meh” market, which has undoubtedly been true. In many ways, it’s better than the rollercoaster of China’s bubbles and bursts this year, or the gyrations of interest rates as worldwide market participants attempt to guess when the Fed will decide to raise them. It’s also preferable to the vacillation of European markets in the spring and early summer as the possibility of Greece’s default loomed once again.
In fact, the very meh-ness of the current U.S. equity market is one reason amongst several why investors might want to focus on U.S. stocks for the remainder of the year. Conditions are just as favorable as they were in January, but with the S&P 500 up barely 1% since then, the relative appeal of these stocks has only increased.
The case for U.S. stocks
The first consequence of slightly improving economic fundamentals and basically stagnating stock prices is price: U.S. stocks are less expensive now than they were at the beginning of the year. They are not at fire-sale prices, but they are cheaper, nonetheless.
On January 1, the price-to-earnings ratio of the S&P 500 was 18.3; at the end of June it was 18.1. During these months, larger listed companies’ earnings improved a tad, but prices barely budged, hence the slight decline in valuation. That in itself isn’t enough to make them substantially more attractive, but it’s a start.
On a relative basis, however, U.S. equities are more attractive than they were at the beginning of the year. Since then, both developed markets, such as Europe and Japan, and a swath of developing markets have done quite well, but their economic fundamentals haven’t improved nearly as much. As a result, developed markets stocks have gone from a P/E of 16.6 in January to 18.4 in June. Emerging market equities also have become more expensive. Given that every investment we make is based on a wide menu of choices, relative performance and value matter: they are gauges to determine whether we invest money in X or Y.
Then there are dividends. Once upon an investing time, dividend stocks were their own distinct category, and, to some degree, still are. Typical dividend stocks, such as utilities and telecom names, have actually had a rough go of it lately. They react to the prospect of rising interest rates (the prospect, mind you, is distinct from the reality, given that rates have yet to rise all that much). But the dividend yield of the S&P 500 as a whole has actually been going up, as more companies decide to boost their payouts to shareholders in lieu of knowing what else to do with their excess cash other than buy back shares. The result is that the dividend yield of the S&P 500 is now 2%, which is only slightly less than the current yield of the 10-year U.S. Treasury, and much more than the yield on other “safe” bonds, such as German bunds and Japanese notes. What’s more, if rates do increase, even somewhat, those fixed instruments will be volatile, and may lose value. Equities, on the other hand, have at least the potential to increase significantly in price, which will, of course, reduce the reported yield, but provide that much more possible upside.
Then there are economic fundamentals. The U.S. economy is hardly a shining star, but it is a relative winner in a world of limited growth and significant headwinds, as the global commodity slowdown hits countries such as Brazil and Australia. The globally changing mix away from commodity dependency, and in the case of China, away from state-sponsored capital spending, both should be positive forces over the long-haul, assuming that social unrest can be contained. And all is not bleak in global land, with India perhaps at a positive inflection point, and the Eurozone, stable and expanding ever so slightly, now that the Greek crisis is resolved temporarily. But by comparison, the United States with its 2.5% economic growth, give or take, is looking rather attractive.
Economic growth is hardly an exact proxy for the strength of an equity market domiciled in that country. Stocks in one country can do well even as its GDP lags, and GDP can expand healthily while stocks stagnate. But there is one other factor that makes U.S. companies unique and, for right now, appealing.
Domiciled locally, invested globally
Larger U.S. companies are, in fact, not entirely U.S. companies—rather, they are global. According to Dow Jones, nearly half (47%) of all sales of the S&P 500 come from outside the United States. This has been true for the past decade, though the percentage has increased somewhat. It means that investing in U.S. large capitalization companies is de facto international investing. To some extent, the 20th century divide between U.S. and foreign and international investing has been eclipsed by the multinational nature of most larger companies. That is true especially for U.S. domiciled corporations that have long looked abroad for new markets and new revenues.
Over the past year, U.S. companies with foreign exposure have lagged somewhat because of a strengthening dollar. Although it is hard to see the dollar weakening significantly, it is equally difficult to see moves in the next months that will be as sharp as what we have witnessed this year. That suggests that the negative dollar effect may have passed, which is yet another reason to view U.S. stocks favorably, especially larger ones.
These are only a few of many factors. Others include the ability of larger companies to achieve true global economies of scale; the continuing efficiency revolution generated by technology and intricate software systems; and the simultaneous decrease of energy and commodity prices and the greater use of renewable resources that reduce input costs for these enterprises. Stocks may rise or fall for a myriad of reasons, but the positive tailwinds for U.S. listed stocks should shape allocations for the period ahead.
All investment portfolios comprise a set of yesses and nos among all available choices. For the moment, U.S. stocks appear to be in a relatively favorable position, because they are priced reasonably compared to other equities globally, their fundamentals are solid if not spectacular, they have a modest but steady dividend yield, and they benefit from global exposure.
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