Randy alligators and other US risks

It’s the alligator mating season in North Carolina. From now until July, alligators – which can normally sleep up to 17 hours a day – suddenly become active and dangerous. They should be given a wide berth.

I don’t suppose the S&P 500 has often been compared to a mating alligator but we have been warning for some time of the higher risks associated with US equities and the need to treat the world’s biggest stockmarket with some caution. Instead, investors in global trackers have been doing the equivalent of standing next to the gator and posing for selfies.

Just seven stocks – Apple, Nvidia, Microsoft, Amazon, Meta, Alphabet and Tesla – make up nearly 20% of the MSCI All Countries World (ACWI) index¹; the US as a whole accounts for about 65%².

There is good reason to have a healthy exposure to the US market. It’s the most competitive environment in the world. It is one of the best capitalised, so companies have the wherewithal to grow. It nurtures good companies well – they can establish their roots in one state and then branch out easily into others because of the common language and frictionless borders. There are no tariffs between California and Colorado to worry about. And it trades in what is still the world’s strongest currency. So, it is a great place to build a business.

The dangers of extrapolating growth into the future

But it has been clear for some time that the American market by most measures is expensive. Investors are extrapolating today’s growth far into the future. That’s human instinct. It’s also dangerous, as we have learned.

When sentiment changes and expectations become more realistic, the impact on share prices can be painful. The table below illustrates this. The markets that were most expensive at the start of the year have fallen furthest. The US fall has been worsened by the weakening dollar. It may surprise some investors to see markets in the UK, Germany and China are actually flat – even positive.

Starting valuations and year-to-date returns of markets

Within our own SmartGARP Global strategy we began the year underweight North America as our typical limits allow – just 45% of the portfolio (and that includes Canada)³. We held nothing in Apple or Tesla, down 15% and 32% respectively year to date. The consequence is that though the fund is down so far this year, it is only down around 6%, compared with the ACWI, down nearer 12% as I write⁴.

The benefits of a quant-driven program

This may sound like boasting. It is not. Credit the prescience of our SmartGARP quant-driven program, which looks at the fundamentals of business performance and scores companies for us to build portfolios around.

At times like this it can pay to remove behavioural biases. SmartGARP does not read Donald Trump’s tweets and does not suffer the roller coaster ride of emotions that come with reading the FT or Bloomberg each morning.

SmartGARP does not read Donald Trump’s tweets and does not suffer the roller coaster ride of emotions that come with reading the FT or Bloomberg each morning. 

It takes millions of pieces of data each night on more than 7,000 companies around the world and automatically churns and processes them to generate a scorecard for us to wake up to each morning.

The human touch is only needed to invest in the way it is steering us and to check for factors the computer might miss in the numbers. For instance, a rise in an egg farm’s earnings because of an outbreak of bird flu decimating supply and causing temporary price hikes.

Pinpointing underappreciated earnings growth

In simple terms, the companies that attract the highest scores tend to have underappreciated growth. They tend to be in regions and sectors that are unloved by the market and yet warrant more interest.

Perhaps not surprisingly, these tend not to be the most glamorous companies or operate in the most glamorous places, but that means SmartGARP can kick out names that don’t appear in many similarly sized portfolios.

There are many investors who continue to watch pronouncements from the US, wondering whether to buy on the dip and whether any recovery that comes with the latest volte-face from the White House is lasting. Based on numbers alone, the computer says no.

Even today, after the market corrections, only 8.7% of SmartGARP’s top scoring companies are in the US; 15% are in China, 41% are in emerging markets more broadly (including China) and 25% are in Europe.

Of course, this is no guarantee that these companies will outperform the market. But to my mind, at a time of heightened investment risk – when the alligators are snappy – focusing on businesses that are delivering good growth and are undervalued doesn’t seem a bad place to be.