After several years of relatively benign conditions for the global economy and investors, this summer might be remembered as the point at which a few cracks began to emerge. It is impossible to make accurate predictions. But it is interesting to ask what the past few unpredictable months have meant to the American investor, and what the future might hold.
To say that the credit crisis of recent months has undermined the foundations of the world’s financial system would be an overstatement. At the same time, though, while the storm might have passed, it would also be na to expect the financial system to have already shrugged off the problems. The impact will be longer-lasting than that.
High-profile heads have rolled; some of Wall Street’s biggest institutions appear to have admitted the extent of their losses, and it looks like this is the straw that is finally breaking the American consumer’s back. If this is the case and American consumers retreat from their unabated spending spree of the past few years, the longer-term implications of this summer’s events might be more profound.
This background makes markets across the world vulnerable to the volatility, which has been the major characteristic of the past few months. One of the triggers of that summer unpredictability was uncertainty and fear. As the concerns about bad debt began to bubble up through the market, investors were unsure as to what exposure they and their counterparts had to the toxic debt that was being exposed.
Given that this delicate environment prevailed, the American market has stood up reasonably well. And while the major indices are off the highs achieved earlier this year, we have not witnessed a cataclysmic descent during the summer and autumn.
But what is left in the immediate aftermath of the summer storm? As time passes, the market’s uncertainty is slowly dissipating and facts are emerging more frequently than speculation. The American economy continues to grow, but the consensus is that this growth is slowing at a rate faster than was originally supposed.
In the housing market, it is possible to observe that American homeowners have some similarities with their cousins in Britain, and that falling house prices can negatively impact consumer confidence. An overstocked housing market and the credit crunch have taken their toll on house prices, and the knock-on impact for the highly geared American consumer is clear. Sales of furniture and cars, for example, are falling while unemployment is slowly rising.
This is happening just as the dollar has weakened further against other currencies. This is a double-edged sword for any economy – a weak dollar is bad for American importers, but welcomed by exporters.
The degree of weakness in the dollar has surprised some market commentators. On one hand, it has prompted speculation that the dollar is settling at a new level – and even in certain quarters, that perhaps the euro will replace it as the default currency for oil trading. On the other hand, it is more likely than not that the dollar might be close to a turning point, driven by a shift in the balance of risk and reward precisely because of the current price.
In this environment, bottom-up stockpicking approaches to portfolio construction lead to a greater-than-normal bias to growth over value, and large over small-cap stocks. It also seems that small-cap stocks may be over-owned at the moment, and are therefore presenting less value to potential investors in their price.
It would be easy to read all these points as a thoroughly gloomy assessment of America as a hunting ground for investors. However, the American economy is not the same as the American stockmarket. About 40% of the earnings of the S&P 500 is derived overseas, meaning that American companies are not wholly inward-looking and therefore susceptible only to the moves of the domestic economy. In spite of whatever woes you believe exist or might emerge over the horizon in the economy, the prospects for many American companies are still attractive.
America boasts both the world’s largest economy and stockmarket, which therefore both possess great depth. About 7,000 listed companies in America means there is coverage of importers, exporters, high-tech, low-tech, big, small, good, bad and ugly. You name it; you can invest in it in America. Investors will succeed in this environment as long as they are able to identify the themes that will profit from the global market conditions.
Thinking of a specific example of this theory, it seems highly likely that the global price of oil will remain high for the foreseeable future. Of course, there will be some benefit for the big oil companies that extract, refine and distribute fuel. In many cases, this is already reflected in these stocks’ prices. However, enduring global demand for oil will mean the race to find new oilfields intensifies.
So an investor could look further up the oil supply chain to specialist oil exploration companies, which are flat out in this race. Then further upstream, there are the companies that supply these firms with geological surveys, ship charter, geological equipment and the like. America is home to some of the world’s leading companies in all these fields.
Additionally, other investment opportunities might present themselves precisely because of the volatility and nervousness in the market. On occasions when sentiment is the main driver for share prices, it is possible to establish or reinforce positions in cheap stocks.
With such a large investable universe of companies available, American portfolio managers have a broad range of potential candidates to choose from. There is always something interesting to buy out there.