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US equity market on diverging trajectory from reality

26 October 2018

Kim Catechis, manager of the Legg Mason Martin Currie Global Emerging Markets Fund comments on the fall in the US equity market.

Markets around the world have fallen sharply so far in October, shaking investors out of their comfort zone. Why is this happening? It’s very simply a question of gravity – the US equity market has been on a diverging trajectory from reality: stocks have been hitting peak valuations as corporates have been reporting peak profitability, whilst the clouds are gathering on the horizon.

The evidence is there in the valuations: the US was, as of Friday, on a PE ratio of 21.6x and a P/BV of 3.3x, a 13% and 30% premium to the 10-year average respectively, and at a significant premium to international markets.

The US economy was already doing well, then it was boosted by an unprecedented tax cut, further fuelling short-term profitability. But that tax cut is a one-off event, and the new tariffs on imported products and the oil price recovery over the last year have resulted in growing inflationary pressures. Hence the Federal Reserve has had to respond with an acceleration of the interest rate cycle.

With inflationary pressures growing, an increasing number of corporates are guiding profitability expectations downwards for 2018 and 2019, citing the negative impact of rising costs and the burgeoning tariff war.

International markets appear to have been reflecting this scenario more accurately year-to-date and now the shakeout would seem to have finally arrived Stateside. Investors now need to understand that the rocket fuel has run out and the coming year or two will prove much tougher for the real economy.

As long-term fundamental investors, we continue to find attractive opportunities in every sector and region, irrespective of the prevailing conditions. Moreover, this environment of macro-driven uncertainties helps to underline the benefits of stock-focused portfolios based on in-depth research and regional expertise, rather than those which are dictated by macro factors or market directional strategies.

Professional Paraplanner