Regular readers know this column’s key theme for 2013 had been to buy equities in stgeloped nations, principally the United States, and avoid emerging markets. A related theme was using unhedged currency exposure to benefit from a weakening Australian dollar.
The first part of that theme worked well: the iShares S&P 500 exchange-traded fund, suggested in this column, rose 38 per cent in the calendar year to July 31, and 46 per cent over 12 months. And emerging markets have been smashed in the last few weeks, amid growing nervousness about a rising Greenback and capital outflows back to the US.
Readers will also recall I suggested taking some profits in US equities in early August: “With limited near-term upside – and rising equity risks in the next few months – it looks a good time to reduce exposure, while maintaining an overweight position to global equities within portfolios, and within that an overweight position to US equities.” The Dow Jones Industrial Average has fallen about 5 per cent from its early August peak.
Nothing in the last few weeks changes my view. Taking some profits on US equities and increasing portfolio cash weightings looks a smart move as equity-market risks build in the next few months. Although the long-term trend is up, a pullback or correction would not surprise.
One of the market’s better judges, John Abernethy, chief investment officer of Clime Investment, warned about growing problems in the US in a recent note to investors.
He wrote: “Economic growth has been stalling in the US and this is reflected in tepid company earnings. Our contention is that US stock indices have moved to elevated levels through an expansion of Price Earnings Ratios (PERs) rather than earnings growth. The expansion of PERs is the result of lower bond yields and these are now correcting.”
Abernethy noted lower recent earnings growth forecasts from the world’s largest retailer, Wal-Mart, and several key economic indicators showing the US’s low-growth recovery continues. The all-important US housing sector “remains sick despite what many commentators suggest”.
Abernethy’s chief concern was the US debt ceiling. “September will likely evolve as the month when debt-ceiling noise will once more become shrill … It is now forecast that the US will reach the point where it is unable to pay its bills sometime between mid-October and mid-November unless Congress increases the limit. Although events in Syria may pre-empt some of these matters, this noise is likely to create some degree of instability within the US and therefore world markets.”
I’m more optimistic on the US’s medium-term prospects. As has been shown repeatedly, US politicians have a knack of solving difficult problems at the last minute, after all other options have been discarded. And the low-growth US recovery still has the benefits of falling energy costs and low wages that will make its manufacturing sector more globally competitive.
But I agree with Abernethy’s short-term prognosis: the risk of instability in world equity markets over the next few months is rising as the emerging-markets rout intensifies, the risk of military action with Syria increases, and as the US Federal Reserve signals it will taper its stimulus program. Equity markets that have risen more on PER expansion than earnings growth further add to risks.
Domestically, the recent profit reporting season was slightly better than expected, but not enough to suggest consensus forecasts for 11 per cent earnings-per-share growth in ASX 200 companies (excluding financials and infrastructure) are easily achievable in an economy that Federal Treasury expects to grow at 2.75 per cent.
The Australian sharemarket, on a forecast PER of about 14 times, also looks fully favoured for now. The economy badly needs a lower Australian dollar to stimulate export sectors such as manufacturing, tourism and education, but our currency has so far defied the rout in emerging-market and commodity-based currencies to stay around US90 cents.
As such, it seems prudent to reduce exposure to domestic and international equities as we head into the seasonally weak September/October period. A storm is brewing on several fronts overseas, meaning a bit more portfolio shelter in case is warranted, in anticipation of buying back at lower prices towards the end of 2013.
AMP Capital’s Dr Shane Oliver made a similar point last week. “Shares are vulnerable over the next month or two with various events and risks that could trigger investor nervousness, including the Fed’s September meeting where it may start to taper its monetary stimulus, US Government funding and debt-ceiling negotiations, the nomination of the next Federal Reserve chairperson, various imbalances in the emerging world, possible military intervention in Syria, political instability in peripheral Eurozone countries and post-election fiscal tightening in Australia.”
He added: “However, a pullback should be seen as a buying opportunity as the broad trend in shares is likely to remain up: valuations are not dirt cheap but they are not expensive either; monetary conditions will remain very easy with interest rate hikes a long way off in the US and in other stgeloped countries and interest rates still at risk of falling further in Australia; and the gradually strengthening global growth outlook points to stronger profits ahead. So by year end we see further upside in global and Australian shares.”
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis are September 5, 2013.