US Markets

US equities are unattractive and there’s danger out there, says portfolio manager

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U.S. equity markets are "broadly unattractive" with a severe dearth of obvious investment opportunities, according to Cole Smead, portfolio manager at Smead Capital Management.

The backdrop for U.S. equities is in some ways even less attractive than in 1999 during the run-up to the dotcom crash, which led to the S&P500 losing over a fifth of its value and the Nasdaq dropping by a half, claimed Smead.

Yet the Seattle-based fund manager took care to draw the distinction that while there was a breadth to the unattractiveness that surpassed that of the pre-dotcom period, the "egregiousness" of the valuations for large caps was less exaggerated than during the earlier period.

Expanding the picture to consider rising longer-term yields in the U.S. and the increasing expectation of a series of interest rate hikes this year in the U.S., Smead said that it was a poor time for indexes, saying investors would be "paying expensive broad prices with a marginal headwind of rates being in the face of stocks."

Smead also cast his cautionary net wider as he considered the broader investment landscape and noted that even commodities had risen significantly in the past year.

"The irony to your point is we can get into an environment where both the bond market and the stock market get hurt at the same time," he said, pointing out that this would be an opposite dynamic to what we have seen over the last seven years.

What does today's stock market have in common 1999?

"That's the oddity of all this – we could get to a situation where general asset allocation could struggle," he added.

At the forefront of Smead's concerns are the valuations of the larger tech companies, with the trifecta of Apple, Microsoft and Google now accounting for over 8 percent of the S&P 500 index.

Drawing on examples from his hometown, Smead highlighted parallels between Amazon today and Microsoft in 1999.

"We just see ridiculous economics going on in multi-family housing, Class A, in downtown, commercial real estate but it's all built on one lynchpin: The price of Amazon stock because employees get paid in restricted stock units," he said.

Back in 1999, a similar dynamic existed at Microsoft where for the following six or seven years it fell out of favor as an employer because the large amount of restricted stock in the compensation package made the overall benefits appear "middling", Smead explained.

His concerns go beyond valuation, noting that the highly supportive environment for tech stocks under Barack Obama's presidency during which Smead says the former administration allowed the sector to "have its way" is unlikely to persist.

He noted President Donald Trump's much tougher stance on the sector as well as an impending change in regime at the watchdog Federal Communications Commission (FCC) which could bring higher charges for many tech companies that they are unable to pass onto consumers.

"What we can learn from this is 'avoid the egregiousness'," Smead advised.

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