Trying to guess the outcome of a national vote is becoming a fool’s errand. Even many of the people who voted for Brexit did not think it would happen. Now we have all learned to be wary it seems no one is willing to take a punt on the US election.
In the lead up to the EU referendum, it seemed equal thought was not put into each scenario by most investors. Indeed, in the days before the vote, a Remain sentiment prevailed in currency and equity markets. In contrast, commentators are falling over themselves to hypothesise on both sides of the fence ahead of the final Clinton versus Trump showdown.
With a finger in so many pies, US politics have international ramifications. Emerging market managers I spoke to recently, for example, believe Trump’s protectionist stance towards American manufacturers and workers could prove disastrous for some developing economies.
Additionally, the question of whether and/or when the US Federal Reserve will raise interest rates again has had investors on tenterhooks this year. Just a small increase in the US base rate can strengthen its currency to the point where it becomes painful for emerging market countries, which usually borrow in US dollars, to repay their debts. The Fed has hinted a rise may be imminent following the election, although this will depend on how markets react to the verdict.
A rate rise could also upset the US stockmarket’s nearly uninterrupted growth since 2009. We are approaching a decade of low interest rates since the global financial crisis. This has forced more and more savers into riskier assets in search of income, such as shares, pushing up their prices. US equities look expensive right now compared to their history and compared to the rest of the world.
This raises two red flags. Firstly, it gets harder to make money when you buy something that is already pretty pricey. Secondly, these valuations make US equities more vulnerable to shocks. Either the election result or a rate rise could become a catalyst for sell-offs, at least in the short term.
That said, it is by no means all doom and gloom in the world’s largest economy. On the structural front, the US benefits from an outstanding business environment. Its educational, legal and financial conditions are highly conducive to innovation, making it the global leader in many high-value industries. What is more, election uncertainty is creating opportunities too.
Some key examples can be found in the healthcare space. Both candidates have suggested drug pricing is an area of concern. A single Tweet from Clinton on the topic last year sent pharmaceutical stocks spiraling. Yet some managers are seeing entry points to buy into high quality companies that have been caught up in indiscriminate selling. Industry-leading firms that invent specialist treatments are thought less likely to be impacted by pricing controls than generic drug producers, while certain companies in health care sub-sectors also look appealing.
Manager of the Elite Rated Brown Advisory US Flexible fund Hutch Vernon initiated a position in Aetna, a healthcare insurance provider, earlier this year. Its valuation was attractive relative to its peers and it has invested in healthcare management businesses for future growth potential, he says.
Manager of the Elite Rated Schroder US Mid Cap Jenny Jones remains overweight healthcare, despite many other managers reducing their exposure. Jones’ fund invests in medium-sized companies, which means she naturally avoids the traditional, big name pharmaceuticals in favour of slightly smaller and more diverse healthcare holdings. She and her team, based in the US, have made a name for themselves as smart stock pickers and the fund has held up well in tough markets.
On a final note, it is worth mentioning that while US equities are above average valuations, they do still look cheaper than US bonds relative to their yield. The gap between the earnings yield of the American stockmarket (the S&P500 index) and the 10-year US treasury yield is currently 3.3 per cent, which is far above its 30-year average of 0.3 per cent. Even if the Fed starts to raise rates, government bonds around the world are offering negligible income for investors. And a rate rise, in theory, signals a stronger US economy.
If you are feeling more confident, I would suggest the Elite Rated Axa Framlington American Growth fund, which does particularly well when the US market is in a growth phase. Manager Steve Kelly looks to capitalise on the US’s innovative and intellectual property strengths. Investors should be aware, however, that because the fund has a preference towards medium-sized, growth companies it is typically more volatile than a large-cap US fund.
Darius McDermott is managing director at FundCalibre