US markets have long had their naysayers. Investors have balked at the high valuations, companies’ fondness for buybacks, the paucity of dividends. However, at every stage they have just got stronger and stronger. Even in 2022, a relatively lacklustre performance was supported by a stronger dollar. UK investors have had little incentive to exit US markets.
There are tentative signs that this is starting to change. The Nasdaq and S&P 500 are around 4.2% and 4.1% behind the Eurostoxx 50 index over the past month, and also trail the FTSE All Share. Refinitiv Lipper data showed investors withdrew a net $12.9bn (£10.7bn) from US equity funds in the week to 1 March, their largest weekly disposal since the start of the year. ETF fund flows show a similar pattern.
This weakness has come in spite of relative strength in the dollar versus the euro, and in the face of strong economic data. The labour market is particularly strong, with new claims for unemployment benefit continuing to fall and labour costs growing fast. In spite of lay-offs from some of the large tech companies, most companies are keeping job losses at a minimum.
Consumer spending has also been robust. US retail sales rose 3% in January, smashing market expectations of a 1.9% growth. Consumers have proved immune to rising inflation, spending more on food, drink, services, motor vehicles and homeware. For the time being at least, they remain buoyed by their Covid piggy banks, which has allowed them to build up savings.
However, it may be the strength of economic data that is proving damaging for markets, suggests Steven Bell, chief economist at Columbia Threadneedle: “Stronger US data could mean more tightening by the US Federal Reserve and higher rates are bad for equities. Plus, the read across from stronger economic data to stronger corporate earnings may not be working. A super-tight labour market means margins are under pressure. We’ve had almost all of the S&P 500 companies reporting results for the fourth quarter. Revenues are up around 6%, but earnings are down 4%. That’s a big squeeze on margins.”
This weakness was confirmed by the most recent ISM manufacturing index. Overall, it showed a modest improvement on previous month, but investors were troubled by the ‘prices paid’ component of the index, which saw an increase, suggesting inflationary pressures may be persistent. This was particularly true for the service sector, which is being hit hard by rising wages. While other countries are also experiencing inflationary pressures, the US has proved particularly vulnerable to wage growth.
Bell adds: “We’ve also had some bad news on inflation and that’s dented hopes that falling prices for commodities and easing of supply constraints on goods would lead to a virtuous cycle of disinflation, with lower wage and price inflation. There were hopes that perhaps the Fed could get back to its 2% target without a recession. That scenario is still possible, but my guess is that we need a recession to get inflation down and it’s just been postponed.”
Stephanie Butcher, chief investment officer at Invesco, says that the worst tail risks to growth have eased, but cracks are emerging in consumer spending. Consumers may be exhausting their Covid savings, and confidence may be falling, as shown by a recent rise in the savings rate: “After falling to a low of 2.4%, the US saving rate has crept up – to 3.4%. It’s still low by historic standards, but the stock of excess saving as a percentage of GDP has fallen in the US compared to Europe.”
At the same time, she says, Europe has started to look a lot better. She says: “The energy crisis in Europe has receded. Europe experienced a warm winter, made admirable gains in its energy usage and built additional storage, meaning there was no rationing and industry has been able to operate as normal. Natural gas prices in Europe now trade below where they were when Russia invaded Ukraine.” It is also benefitting from the reopening of China.
The high valuation of US stocks may also be catching up with it. Rising discount rates have made investors more valuation-sensitive. This hurts the US, where valuations remain notably higher than elsewhere. Butcher says: “The strength of corporate balance sheets could play a greater role in determining returns in coming years. US stocks look much more richly valued against much of the rest of the world. US equities continue to trade at a premium to the rest of the world and to their own history.” European equities have only been cheaper than they are now 5% of the time.
Overall, the US markets appear most vulnerable to the ‘good news is bad news’ phenomenon. The high valuations and dominance of the technology sector make them uniquely sensitive to further changes in interest rates. After a long run when US equities were the only game in town, investors may finally be tiring of the sector and looking elsewhere.
