It is not just Joe Biden’s nomination to run against Donald Trump in November’s presidential election that has caught our international attention in recent days as we occasionally look west. The dramatic rise of the American stock market, fuelled by ‘tech’ fever, has also caught our eye – especially those with money invested in Isas and pensions.
But while Democrat Biden seems very much on course to remove Trump from the White House, opinion is not so clear cut on where the American stock market – and in particular the S&P500 index (the barometer of the performance of the country’s biggest listed companies) – is heading. Indeed, it is very much divided.
Against the backdrop of the S&P500 hitting an all-time high in recent days and Apple’s market capitalisation breaking through $2 trillion (in pounds, £1,528,270,000,000) – only six months after being valued at $1trillion – experts have been keen to express an opinion.
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James Montier, a renowned market commentator at asset manager GMO described US company valuations as ‘absurd’. By contrast, the FTSE All-Share Index of the top 613 London-listed shares is still down 20 per cent on the start of the year.
Montier went on to say: ‘The US stock market looks increasingly like the hapless Wile E Coyote, running off the edge of a cliff in pursuit of the pesky Roadrunner but not yet realising the ground beneath his feet had run out some time ago.’
Appropriately, his comments were made in a document entitled: ‘Reasons (Not) To Be Cheerful.’ Obviously, a fan of the music of the late, great Ian Dury (Reasons To Be Cheerful, Part Three).
Experts at Goldman Sachs were more sanguine, preferring to hedge their bets a little. It believes the course of the S&P500 Index will very much depend on the development of an ‘early’ vaccine for Covid-19 – by the end of March next year. If this happens, and it says this ‘upside’ view is currently the most likely of three possible scenarios, then the S&P500 could rise to 3,680. It is now at 3,397. In its worst case ‘downside’ scenario – a second wave of coronavirus leading to ‘significant retrenchment’ in consumer spending – Goldman Sachs says the S&P500 could fall back to 2,150.
Experts closer to home that I spoke to last week sit more in the Montier than the ‘optimistic’ Goldman Sachs camp. ‘Do you think the S&P500’s recent run (up 44 per cent since the market’s low in March) is sustainable,’ I asked Jason Hollands of wealth manager Tilney – he’s always happy to give an opinion or two. ‘No, I don’t,’ was his immediate response.
Although Hollands accepts that the likes of Apple, Amazon and Microsoft have all been ‘beneficiaries’ of the pandemic – more use of mobile phones, greater online purchasing and an increase in working from home – he says the recent increase in their market capitalisations is a reflection more of ‘bloated valuation premiums than their underlying growth’. In other words, they’re grossly overvalued. Hollands is increasingly perturbed by the distorting impact of the ‘big five’ tech stocks – Apple, Amazon, Alphabet, Facebook and Microsoft – on the S&P500. At the end of last year, the combined market capitalisation of these five accounted for just over 15 per cent of the S&P500. Today, it’s heading towards 25 per cent.
‘It would be supremely naive to think that this trend can continue,’ he warns. ‘Valuations in these tech parts of the market are showing bubble-like characteristics as investors chase returns. UK investors need to be especially careful ploughing more money into these stocks and investment funds with big holdings in them.’
For most UK investors, exposure to these tech giants will be limited because most of their assets will be invested in the UK. But many of the country’s big global investment trusts – popular with many investors – have chunky holdings in US listed tech shares. And of course funds such as Allianz Technology – see Fund Focus opposite – have a big slice of their assets in big American tech shares and still believe there is potential for investors to make stellar returns.
The country’s biggest investment trust Scottish Mortgage, valued at £13billion and a constituent of the FTSE100 Index, has made serious money for its investors as a result of its exposure to US tech stocks and other US ‘disruptors’ such as electric car manufacturer Tesla and California-based internet entertainment business Netflix. Over the past year, it has generated an astonishing 72 per cent for investors. Over the past five years, it has turned an investment of £1,000 into just short of £3,700.
Analysts at Stifel now believe that in light of the trust’s exceptional performance, it is time for investors to think about taking some profits – locking in gains by selling a slice of their stake. Although it still views Scottish Mortgage as a ‘core holding’, it says ‘share prices don’t rise in a straight line indefinitely’ (blindingly obvious, but a timely observation all the same).
A number of events, Stifel argues, could disrupt the trust’s rise: a move away from growth stocks (the Teslas, Netflixs and Amazons of this world) to more ‘value’ stocks (see below), a less tech-friendly political backdrop triggered by a change of President in November, and ‘market questions’ over the valuations of tech and growth stocks. ‘Banking some profits could be a contrarian, but prudent course of action,’ it concludes.
It is a conclusion all investors with longstanding holdings in global investment trusts that are heavily invested in US tech shares should now seriously mull over. The likes of Edinburgh Worldwide, Martin Currie Global Portfolio, Mid Wynd International, Monks and London & Manchester – trusts with at least 40 per cent of their assets in the United States and which over the past five years have all delivered returns in excess of 100 per cent.
In banking profits, investors should ensure they do not fall foul of nasty capital gains tax. Crystallised gains of up to £12,300 in the current tax year (ending April 5, 2021) are exempt, as are profits taken within an Isa or pension. Above the £12,300 allowance, gains are taxed at 10 per cent (basic rate taxpayers) and 20 per cent.
In light of a current review of capital gains tax ordered by Chancellor Rishi Sunak these rates could rise in the future, although it is unlikely any hike would be introduced before the start of the new tax year. The same argument on banking profits applies to North American investment funds and global technology funds. Better safe than sorry.
Fund manager Hugh Sergeant says some company valuations in the US are ‘very high’ and investors risk losing ‘permanent capital’ if they continue to buy into such stocks either directly or indirectly through an investment fund.
Sergeant, who works for investment house River & Mercantile, believes that many leading US shares – growth stocks including technology companies – are now attracting ‘hot money’ and should be avoided. He is alarmed that Apple’s market value has doubled in six months.
The fund manager, who has spent more than 30 years working in the City, is a passionate advocate of ‘value investing’ – and argues that ‘now is the best time for many years to invest in value stocks’.
In simple terms, value investing is built around identifying companies whose shares are significantly undervalued in light of their anticipated profits and revenues. In other words, they are businesses whose shares stand a good chance of recovery. It’s a style of investing that has proved unpopular over the past five years as enthusiasm for technology stocks, ‘disruptive’ companies and growth-oriented businesses has surged. An enthusiasm fuelled by low interest rates and the ability of many growth companies to borrow cheap money to expand their operations.
Sergeant says that if the world economy – and it’s a big ‘if’ – continues to recover from the fallout caused by coronavirus, and deflation turns to reflation, this will boost the profits of many ‘value’ stocks. Examples include the likes of banking group Lloyds, online estate agent Purple Bricks, and in the United States Walt Disney.
Emma Wall, head of investment analysis at wealth manager Hargreaves Lansdown, says history shows that ‘when value bounces back it does so with gusto’. She advises investors to ensure their portfolios embrace ‘all investment styles’ as well as diversify by asset class and geography.
Simon Molica, a fund manager with AJ Bell, says value investing will come back into favour. He adds: ‘I can’t really say what the ideal exposure to value is, but what is vital is that investors regularly rebalance their portfolios, selling winners and reinvesting in stocks and funds that maybe have fallen in value, but where a strong investment case remains,’
Funds that have a strong ‘value’ approach to investing include Fidelity Special Values, Fidelity Special Situations, Schroder Global Recovery, Schroder Recovery and Man GLG Undervalued Assets. River & Mercantile’s Sergeant runs R&M UK Equity Long Term Recovery and R&M Global Recovery.
Brian Dennehy, managing director of FundExpert, says he is currently switching clients with heavy cash positions into value oriented funds such as Schroder Recovery. He is doing this monthly over a two-year period. ‘If the market collapses in the interim, we will accelerate that investing,’ he adds.