North America has been one of the best performing markets in the year to date, with the S&P 500 recently hitting a four-year high. But concerns are growing that US equities have had their run and that it may be time for investors to exit.
Earlier this year, many investors and advisers believed that the US was one of the better options in terms of developed markets exposure, with some even encouraging an increase in exposure to the area (see our Fund Tips for 2012), but opinions are now changing.
"We favoured the US at the start of the year because its gross domestic product (GDP) seemed to be doing better than other markets," says Darius McDermott, managing director at discount broker Chelsea Financial Services. "US equities were not cheap but seemed to have good momentum."
"Now that US equities have had a decent run, and as they are more expensive than their long-term average, while I would not say to take all your money out, if you had moved into this market strategically in the last year or two, you could take some out. However, if you have a long-term allocation to the US then you should not move your money."
Chartered financial planners at Informed Choice have become slightly more cautious on US equities following a series of profit warnings from some major US companies, casting doubt over the potential for strong returns in 2012. Downward revisions to the growth outlook for some major US companies, including Procter & Gamble and FedEx, resulted in their share prices falling. "Our house view for US equities is to move from an overweight to a neutral position, in recognition of slower economic growth and lower profit forecasts for the remainder of 2012," they say.
Meanwhile, Rob Pemberton, investment director at HFM Columbus Asset Management, expects single- digit annual returns from the major global equity markets, so that a return of around 12 per cent in the year to date from the S&P 500, and even more from the Nasdaq, means that US markets have already over delivered in 2012. "These markets are due a period of consolidation," he says. "Longer-term fundamentals in the US look better than those in the UK and Europe, although this has already been discounted to an extent by the better returns in 2012 and the more expensive valuation."
Storm ahead?
"There are clouds on the horizon, which are approaching fast and could be nasty," says Tim Cockerill, head of collectives research at Rowan Dartington, arguing in favour of reducing an overweight allocation to the US.
These 'dark clouds' include the so called 'fiscal cliff': if US politicians let current policy go into effect, there will be a number of tax increases and spending cuts at the beginning of 2013 that are likely to slow growth. Some people think there could be a contraction in GDP as great as 4 per cent, possibly driving the economy back into a recession. An alternative would be to cancel some or all of the tax rises and spending cuts, but the US parliament is failing to agree on what to do. There is also a presidential election in November which could affect markets.
US equities, in particular large-caps, are also vulnerable to global economic influences such as a slowdown in China or the eurozone crisis.
Long-term value
But there are good reasons to maintain an allocation to US equities. "When the equities from one region outperform others, it should always raise questions about their relative valuations," says Martin Bamford, managing director of chartered financial planner Informed Choice. "But despite US equities reaching a four-year high, we continue to believe there is long-term value in this region for investors who are prepared to accept some short-term volatility. Compared with historical valuations, US shares are probably not overvalued on a long-term basis. In the short term, it is more likely that the rally will run out of steam and investors will experience a correction."
Julian Chillingworth, chief investment officer at investment manager Rathbones, is maintaining his overweight position of 18 months because he believes US equities will offer reasonable growth versus others. "Nowhere is as cheap as it was, but US equities will get some support, and while large-caps are expensive you can find value in mid-caps. The US still offers the biggest range of opportunities for investors as it has a number of growth companies and it is the only developed market with a decent technology sector."
A number of factors should help the US to grow. Natural gas, a key cost for US factories, is in abundance in the US and extremely cheap compared with the rest of the world, which is of help to manufacturing. It is also helping the margins of companies that produce chemicals and refine oil, examples being Westlake Chemicals and Marathon Petroleum.
The US is home to a number of world-class companies, the dollar is the world's reserve currency and it is still the biggest economy by a long way. US banks are seeing rising demand for loans from both businesses and consumers.
"US banks are much better capitalised than UK and European ones, and have largely gone through their write-offs," says Colin McLean, managing director of SVM Asset Management. "US construction and housing sectors, representing in total one-sixth of the US economy, are steadily recovering and we believe that US recovery will beat expectations. We have exposure to these sectors via shares such as UK- listed Ashtead and Wolseley, which have high US exposure and are benefiting also from improving pricing."
Consensus predictions for US GDP growth are around 2 per cent for 2012 and 2013. The US dollar may also appreciate against sterling which would be an added bonus for UK investors with an allocation to the country.
Mr McDermott suggests an allocation to US equities of up to 20 per cent for a balanced investor. Lower- risk investors should allocate less as they could still experience currency and market volatility, while higher-risk investors should maybe have less in the US and more in high-growth areas such as emerging markets.
