US stocks are falling

March 2015

Is the party over for Wall Street? Over a five-year period, the US stock market has left its rivals trailing, as investors have celebrated recovery from the financial crisis. Zoom in to the period since the start of the year, however, and the S&P 500 is bringing up the rear.

By contrast, Europe’s stock markets are climbing as the combination of cheap oil, a newly competitive currency and the promise of 60 billion euros a month of bond buying by the European Centrla Bank make the region seem a one-way bet. It’s the same story in Japan. Even the UK, dragged down by its heavy weighting to out-of-favour commodities and facing an uncertain election, is in positive territory.

The principal concern for investors in US equities is the seemingly unstoppable rise in the value of the US dollar. The idea that this would make it attractive to hold US assets has been blown away by the reality that it is bad news for US multi-national corporations. The money they earn overseas is worth significantly less on translation back into US dollars than it was this time last year. And their goods and services are far less competitive than they were.

In the final few months of 2014 companies such as Apple, Pfizer, Procter & Gamble and Microsoft grumbled that the strength of the US currency was holding their profits back. Now the numbers are confirming their fears. For the first time since 2009, in the depths of the post-Lehman slump, US company profit growth is expected to fall for two consecutive quarters.

Even without a soaring US dollar, US earnings would be under pressure from the collapse since last June in the oil price. Energy companies are the principal contributor to the earnings slide as oil and gas producer revenues have taken a hit, long before the expected boost to consumption benefits other sectors. Analysts have slashed their forecasts.

If US shares were cheap, this recalibration of earnings expectations might not matter. But after almost trebling in value since the dark days of 2009, US stocks are the world’s most expensive. Not ridiculously so, by historical standards, but high enough that a temporary fall in profits has unsettled investor sentiment.

With the Federal Reserve likely to drop a key reference to being “patient” about the first hike in US interest rates since 2006, investors are unsurprisingly looking around for better places for their money. And for the first time in a while there are some half-decent options available.

Europe and Japan are engaged in massive economic-stimulus programmes that are driving their currencies lower and underpinning financial asset prices. With the current bull market in US shares now ranking as the fourth longest since the Great Depression, it is unsurprising that people are questioning how long it can go on.

That’s the bad news. Before anyone turns their back on the world’s biggest stock market, however, they should consider the counter arguments. The first of these is that US growth is expected to bounce back in the second half of 2015 as consumers spend the extra money they have left over after filling up their cars.

Secondly, one key measure of the US economic growth – job creation – is still firing. Ironically, one of the principal reasons for the market’s recent weakness was the strength of the jobs market – 295,000 jobs were created in February and the unemployment rate is falling to historic lows.

Thirdly, the US corporate sector recently notched up nearly four years of double-digit dividend growth. Over the past 15 quarters, dividends have grown at an annualised rate of over 14%. In an environment of persistently low interest rates, in which income is prized by investors, it is unsurprising that US shares have responded so positively. What they are not paying out as dividends, many other US companies are using to buy back their shares, which makes valuations more palatable.

Finally, the US is home to some of the most profitable businesses on the planet. Its market is weighted towards the best-performing sectors – such as healthcare and technology.

The US stock market is no longer cheap and is more vulnerable than most markets to an arguably overdue correction. But it still deserves a place in any portfolio.

Financial information comes from Bloomberg unless stated otherwise.

Important information

References to specific securities should not be taken as recommendations.

Investments in small and emerging markets can be more volatile than investments in developed markets.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment.