Where next for US equity markets?

Emerging Markets ADB editions, May 2 2013

As the S&P500 hits record levels, fund manager and analyst opinion is sharply divided on where US and global equity markets are going next.

On Wednesday a new report from McKinsey proclaimed that “it would take catastrophic changes in real economic performance spread over multiple decades in the real economy, or a fundamental shift in investor behaviour – unlike anything we’ve seen in more than a century – to reduce long-term equity returns to below around 5% in developed markets.”

Yet, even with the market touching record highs, the experience of many investors in developed markets has been 13 years of volatility in order to stand still since 2000. Some fund managers believe markets will, by and large, continue to hover around that level; others, that in the absence of anything else practical to do with cash, flows into stock markets will automatically make them go up.

In the cautiously positive camp is Justin Urquhart Stewart, co-founder of Seven Investment Management. “Companies are coming out with quite good results, producing profits and paying dividends,” he said. “So given that everything else worth investing in isn’t worth investing in, equities are the only game in town. There’s no reason you would expect huge gains from here, and there will be some pullbacks, but the difference between this and last year is people will be buying on the dips.” In his view, the global economy is healing and a great deal of money is coming out of cash, and if the market passes the German election later this year without any disaster befalling markets in the meantime, sentiment should continue to improve.

In the negative camp is Mark Tennant, chairman of Bluerock Consulting. “My own view is we’re entering a period in the developed markets – the US, UK and Europe – which Japan entered in 1991,” he said. “We’ve flatlined for 13 years now, and we’re probably going to flatline for another 13 years. It will go up and down, but the economy is not getting traction.” He blamed two things for that: the amount of wealth that was wiped from the market in 2008; and the growing ageing demographic in the west, with people moving from saving, to spending their savings in retirement.

On average, though, managers appear to be broadly positive. HSBC yesterday [MAY 2] released its quarterly survey of fund manager sentiment and found 57% of global fund managers favouring equities in the second quarter of 2013, with nobody underweight. 57% were also positive on North American equities (14% underweight), 43% on Europe ex-UK (14% underweight), and 57% emerging markets (none underweight).

Economists tend to have divergent views on different parts of the world equity market, dispelling the sense that a rising tide lifts all boats. At Credit Suisse, for example, chief global equity economist Andrew Garthwaite is underweight Continental Europe – and deepened that underweight position in March – on the grounds that it is expensive on price/earnings relatives compared to global markets. But he is overweight Japan and emerging markets, citing seven reasons in an April briefing note ranging from their price/book discount to global markets, to capital flows and their relative underperformance relative to emerging market fixed income.

But emerging markets also divide investor opinion. Tennant, otherwise thoroughly bearish, said he believes the world is in “a situation where emerging markets outperform developed markets for a long period of time,” although he added: “The fact that developed markets don’t have enough money to buy their goods is not going to be terribly helpful.” He said: “You’re going to see a lower rate of growth, but growth we will see.”

Urquhart-Stewart, in contrast, said China “is going to have more issues” than the west “because it’s not a matter of a hard or a soft landing; they’ve landed in a swamp. With a banking system that makes our banks [in the UK] look quite good, and an accounting system that is nothing if not imaginative, people will not pin too many hopes on that.”

In Asia, in a new report to clients this week, Credit Suisse recommended investors buy “undervalued Asian recovery stocks with a positive catalyst from quarterly earnings surprises.” And HSBC’s head of equity strategy, Herald van der Linde, told clients in April he “continues to see 15-20% upside in Asian equities in 2013.”