Over the last six-to-eight months the US has dominated headlines, with the threat of a potential trade war with its key trading partners, a landmark nuclear disarmament agreement with North Korea and a record-length bull run just some of the events keeping it firmly in the headlines. 
Coupled with uneasy European and UK politics, as well as climbing government bond yields, and it’s unsurprising that the third quarter of 2018 saw consistently elevated volatility across all the major asset classes.
During this turbulent time for global politics and, subsequently, the global stock market, investors appear to be seeking apparent certainty in the form of paying ever higher prices for the growth stocks that have already delivered, while paying lower prices for everything else deemed less certain.
Nowhere did this manifest more clearly than in the US. Rather than a universal move upwards, the significant impact from dollar strength and also material regional variations regarding the impact of big picture issues, in particular Trump’s aggressive positioning on trade, have been positive for US growth equities alone, and negative for nearly everything else.
In essence then, the already expensive ‘certain growth’ stocks (think the FAANGs in the US in particular) are being adored, while the cheaper ‘uncertain’ stocks globally are being ignored.
With such a narrow universe of stocks doing well in the US and hot money flowing into popular investments with little consideration for the price paid, it may be time to consider that the US stock market has seen the best of its cycle, with more attractive investment opportunities to be found in the UK, emerging markets, Japan and Europe.
The numbers alone paint a stark picture. The S&P 500 has rocketed by almost 30 per cent since Donald Trump was inaugurated as US president, making the US the world’s most expensive major stock market. At present, US stocks have an average cyclically-adjusted price-to-earnings (CAPE) of over 30x, which is significantly higher than its historical average of 24x.
By contrast, the equity markets across the rest of the world (global equities excluding the US) currently have CAPE scores of less than 15x, and personally, I would rather take advantage of these more modest valuations.
It remains my contention that the US equity market has therefore seen the best of its current run up, with profits more than fully recovered and the multiple that is put on those full earnings being high. In comparison, the rest of the world has lagged behind and is earlier in the cycle, with far more modest valuations and more potential for profit and return on equity. The valuation gap between the rest of the world and the US has opened up further over the last quarter alone, and I remain very comfortable to exploit it.
When selecting stocks, using our ‘PVT’ – potential, valuation and timing – process, we attempt to buy firms with the potential to grow their profits both at the right time in the cycle, and at a good price.
An example of this is the recent increase of our fund’s stake in UK firm Chemring, which can be described as a ‘recovery stock with the potential for higher return on capital in the medium term.
A new management team has evolved the business from a financially vulnerable, short-cycle business exposed to the ups and downs of conflict budgets to one exposed to higher quality long term contracts, supported by a strong balance sheet. This, combined with a focus on operational efficiency, makes us believe there is a good reason to expect higher return on capital in the medium term.
Another UK stock I favour is Lloyds Bank. In my opinion, there is a misperception of Lloyds based on its past decade - that of a business with structurally low profitability, a risky balance sheet and legacy liabilities. The resultant investor apathy has allowed a material gap to open up between the equity valuation and the reality of the business today.
The fund has also bought into a number of emerging market-facing firms, such as Brazilian transport company Ecorodovias, insurer Prudential, and Baidu, which is the leading internet search engine in China.
Looking at Baidu in particular, it has lagged the momentum of the US FAANGs (Facebook, Amazon, Apple, Netflix and Google) and remains a top decile scoring recovery stock, rather than a very expensive ‘all the positives known about’ internet stock; its returns are relatively depressed and bottoming out as recent investments start to be monetised and, with a free cash flow yield of over 5 per cent, is attractively valued.
These types of stocks have been ignored by Mr. Market who is focused on paying higher and higher prices for the already fully delivering expensive growth stocks; we are paying lower prices for everything else that has been left behind (for whatever reason) in the stampede of hot capital into ‘guaranteed’ growth.
Hugh Sergeant is a fund manager at River and Mercantile Asset Management. The views expressed above are his own and should not be taken as investment advice.