Is it Time to Move Out of the US Stock Market?
Over the past decade, the US stock market has been a profitable choice for investors, even attracting UK retail savers who shifted their funds from the struggling London market to America. However, as stock valuations soar and rely heavily on the performance of a few mega tech companies, the question arises: is it time to consider other options?
In addition to high valuations, the US is entering a presidential election year, which is expected to fuel political battles and public uncertainty. Such an environment is hardly conducive to making calm and rational business decisions.
The trading volume of options linked to the Vix volatility index, known as Wall Street’s “fear gauge,” is predicted to reach a record this year. Investors in equities are seeking protection against the risk of a sudden market reversal. In fact, daily trading of Vix options has increased by over 40% compared to the same period in 2022, surpassing the previous full-year record set in 2017.
While the US is renowned for its economic resilience, it may be wise for investors to explore alternatives. Conversely, should they continue to place their bets on America and its flourishing tech sector? FT Money delves into the arguments.
Too Big to Ignore
Investors cannot overlook the US stock market, as it holds significant weight in the global equity market. Fluctuations on Wall Street often set the tone for other markets worldwide. The US also dominates global equity valuations.
Consider an investor seeking diversified exposure to global equities through a fund tracking the MSCI World index. In reality, they are essentially making a bet on the US market, which comprises about 70% of the MSCI World. This is the highest weighting that Wall Street has ever had. In the late 1980s, the US market made up only 30% of the MSCI World, and Japan briefly surpassed it.
What’s even more striking is that the current performance of the US stock market hinges on a handful of companies. According to Torsten Slok of Apollo Global Management, the top 10 firms in the S&P 500 account for 34% of the index. This concentration is the highest since the dotcom bubble in the early 2000s. These stocks trade at an average price/earnings ratio of 50, signifying that buying US shares is essentially a bet on the ability of these stocks to maintain their high ratings and rapid profit growth.
Many of these influential companies belong to the tech sector, such as Apple, Alphabet (Google’s parent company), Amazon, and Meta (Facebook’s parent). Other market giants include Tesla, Berkshire Hathaway, and Nvidia. Their performance has propped up the S&P 500 index in recent years and has become crucial for investors.
Regulatory Threat to Tech Boom
While certain stocks have high valuations due to market dominance or premium pricing, many of these companies face regulatory attention. For instance, Apple’s share price recently dipped after the Chinese government imposed restrictions on the use of iPhones by public officials. In September, the EU designated 22 “digital gatekeepers” subject to a new regulatory regime, which includes services operated by Alphabet, Amazon, Apple, Meta, and Microsoft.
In the US, the Federal Trade Commission has filed an antitrust suit against Amazon, accusing the company of inflating costs for consumers and sellers. What’s concerning is that tech companies attract criticism from both Republican and Democrat politicians.
Keep an Eye on the Fed
Short-term fluctuations in the US stock market often depend on the actions of the Federal Reserve. The central bank has been gradually raising interest rates since March 2022 to counter inflationary pressures resulting from Russia’s invasion of Ukraine and energy market disruptions. However, at its recent meeting, the Fed kept rates unchanged and suggested that there may only be one more rate hike in the current tightening cycle.
This decision was in response to a slowdown in US inflation rates, although they remain above the Fed’s target. Consequently, the central bank intends to maintain rates at their current levels for an extended period. This raises concerns about the potential impact of rate increases on pushing the US economy into a recession. While many anticipated a recession at the beginning of 2023, the economy has held up well so far, with the Fed forecasting a 2.1% growth rate for this year and 1.5% in 2024.
However, worrisome signs exist, such as the yield on longer-dated bonds being lower than shorter-term securities. Historically, this inverted yield curve has preceded every US recession in the past 50 years. Nathan Sheets of Citibank believes that the US economy will eventually face a recession in 2024, as unwinding high inflation alongside tight labor markets has consistently led to an increase in unemployment rates.
These factors create a potentially challenging backdrop for US stocks. Additionally, US corporate profits have been lackluster lately, with data from the Bureau for Economic Analysis showing a decline in profits in the first quarter before a modest increase in the second quarter.
US Presidential Election Could Impact Stocks
The upcoming US presidential election in 2024 is expected to dominate news headlines. It is likely to be a rematch of the 2020 election, pitting current President Joe Biden against former President Donald Trump. Historical trends suggest that markets favor Republican presidents, although major crashes and crises have occurred during Republican administrations as well. Over the past 70 years, the average annual return under Democrat presidents has nearly doubled that under Republicans.
Despite the turmoil during Trump’s first term, the US market reached record highs until the pandemic hit in 2020. Investors were particularly drawn to the sweeping tax cuts implemented in 2017, including a significant reduction in the corporate profits levy. However, nervousness is expected to increase as the election day approaches, considering the increasingly dysfunctional and confrontational nature of the US political system.
The aftermath of the previous election was marked by chaos when Trump refused to accept the result, and his supporters stormed the Capitol. Given this context, it is crucial for investors to carefully monitor the implications of the US presidential election on the stock market.
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