During the last quarter US economic strength led market sentiment, resulting in a widening valuation gap between the US market and the rest of the world. This widening gap implies a much more favourable backdrop for long-term returns outside the US. Expectations of non-US countries are not only lower, but their economic cycles are lagging the US.
Many US companies are reporting margins that look to be very close to peak levels, and corporate tax rates are currently at the lowest levels in decades. That makes it a bit more difficult to find value in some US companies. So, while there are some individual bargains in the US, we are finding greater value elsewhere, in particular:
- European Financials: Recent weakness in the European banking sector has resulted in compelling valuations. Profits have improved, and we’ve seen steady lending growth. Bank balance sheets are stronger, and the bulk of the destabilising post-GFC reregulation efforts is also complete. Looking ahead, we think a less-accommodative European Central Bank policy stance could be positive for bank earnings as higher rates support higher net interest margins.
- The United Kingdom: The UK’s planned departure from the European Union next year presents some uncertainty for UK companies, so our strategy has been to focus on quality UK-domiciled multinationals that source most of their revenue abroad. We also favour companies that are defensive in nature and less likely to be impacted by an economic slowdown.
The US market is trading at the largest P/E premium to the rest of the world in the last 30 years, at a time when US profits are extended and in contrast to fixed income markets which offer a more attractive yield to US holders than those in other developed economies. As such we continue to favour non-US equities over those in the U.S., where current valuations, in our view, warrant caution.
US Reaches 30 Year High, Outside the GFC