Investors should remain overweight US equities and beta-driven assets despite high valuations, according to Goldman Sachs Private Wealth Management chief investment officer Sharmin Mossavar-Rahmani.
Mossavar-Rahmani said US equities are not yet in bubble territory and are driven instead by underlying earnings and continued economic growth, with the current level of inflation volatility also supporting the asset class.
“Valuation alone is not a good argument to be underweight US equities,” she said. “There are many steady factors improving in the region and when you look at valuations in a context, actually you realise the asset class is not that expensive.”
The years following the global financial crisis were characterised by a strong performance of the US and global economies and financial markets, with the world largest economy registering its longest period of post-war growth.
While 2017 saw almost all equity markets deliver strong returns, this year has seen a shift away from synchronised global world with the US decoupling from other markets.
Performance of main indexes YTD
Source: FE Analytics
Despite the threat of a potential trade war after president Donald Trump increased export tariffs on trade partners, US stocks have continued to rally.
However, many market participants have warned that this bull market is in bubble territory, and fear of high valuations in the US market.
Mossavar-Rahmani believes investors should remain invested in US equities, as the country continues to benefit from some “steady factors” that have improved since the beginning of the year.
Not only that but the country isn’t expensive when putting it into historical context, the chief investment officer said.
“In the US we have been in a regime of low inflation and stable inflation since April 1996,” she explained. “If you look at valuation metrics when inflation is low and stable, valuation metrics on average are much higher.
“So, if you look at these metrics and compare them to the long-term average yes, we are in 10th decile so valuations are certainly much more expensive but that is to narrow a [time] frame. You have to look at it in the context of low stable inflation and once you do that you realise equities are not that expensive.”
As such, Goldman Sachs Private Wealth Management’s Mossavar-Rahmani said although current S&P 500 price-to-earnings (P/E) ratio multiples are 49 per cent above long-term median levels in aggregate, they are only 14 per cent above the median level of the current low and stable inflation regime.
S&P 500 PE Ratio
Source: Multipl
“When you look at this, certainly when you think about valuation and how overvalued you are the perspective of expensive valuations changes a lot so I strongly recommend looking at the aggregate,” she said.
“When people say we are approaching valuation levels seen in the 1990s, valuations are nowhere near the levels of the peak of the US equity market bubble in 1990.
“They are moderately expensive but still nowhere near as where the hype would suggest.”
The current backdrop has improved since the beginning of the year, said the investment chief, with positive earning numbers in major economies, a reason why looking at fundamentals is key.
Despite four consecutive quarters of declining earnings in the US during 2017, Mossavar-Rahmani noted that 2018 Q1 earnings before interest and taxes reached their highest level for more than a year, dispelling the notion that they were driven primarily by tax reforms introduced by Trump.
“At the end of the day we have now a very favourable tailwind for the earnings, that’s why we say you have to look at the fundamentals,” she said. “We have to look beyond the volatility caused by geopolitics into these type of factors.”
When it comes to the S&P 500 index, she said the penalty for exiting equities prematurely can be sizeable.
As such, if in November 2013 investors had just used valuations and reduced exposure to equities because they thought they were expensive (ignoring all other factors) they would have left 72 per cent returns on the table.
“This is pretty phenomenal, with equities, the odds of winning are much higher than when you go overweight as things are very cheap,” she said
“US equities is an appreciating asset class over time and a pure valuation strategy doesn’t work, even when you look at CAPE [cyclically-adjusted P/E] Shiller [ratio].
“The market could go down but it goes up from such high levels than you never will get a chance to get back in at a better level.”
S&P 500 earnings
Source: Multipl
Notwithstanding a potential ‘tug of war’ between steady market factors with an unpredictable undertow, the chief investment officer said recommendations can’t be based alone on “unsteady factors”.
“An example is August 2017 at the height of geopolitical tensions between US and North Korea,” said the Goldman Sachs Private Wealth Management chief investment officer.
“If we had chosen to go underweight US equities based on worries of how the US-North Korea geopolitical tensions could end up, today we would have left about 14 per cent total return on the table.”
Mossavar-Rahmani highlighted several unsteady factors worth keeping an eye on, including: heightened geopolitical tensions, rising populism, the increasing threat of cyberattacks, contentious domestic politics or bitcoin and the cryptocurrency mania.