Making a case for investing in pricey US stocks

As we come to the end of the second quarter earnings season, both in the US and across Europe, the case for owning US listed equities over European stocks continues to strengthen.

Management teams across the US indicated in their results releases and subsequent conference calls that while global growth remains well below desired levels, it is a macro environment that has persisted for some time and companies have had to get used to it.

The outlook for the remainder of 2016 is for sluggish economic growth but from which corporates have continued to adapt through cost cutting and reduced capital expenditures, and deploying cash towards share buyback programmes.

Over the longer term, such capital allocation decisions will have a negative impact but in the shorter term, it augments company profitability levels and buys investors time for the much-vaunted global economic growth induced by central banks.

One of the frequent pushbacks against investing in the US has been that valuation multiples for the market are not low and by no means cheap, particularly when set against European ones.

While this is true and the S&P 500 trades on 17.5 times forward year earnings compared to 15.4 times for the Stoxx 600 index in Europe, the quality of the US companies tends to be higher than those in Europe.

When looking at most global industries, the respective bellwethers are typically large US companies that European and Asian competitors try to emulate.

Taking the technology sector as an example, US companies dominate through companies that include Alphabet, Facebook, Microsoft, Intel, and Oracle. In Europe, beyond SAP and Nokia, there are few very large technology companies.

In healthcare, the world’s leading pharmaceutical, medical device and biotechnology companies are listed in the US. Companies such as Pfizer, Johnson & Johnson, Medtronic, Merck, Amgen and Gilead lead the global field.

The US is also relatively safe with regards to its banks. That’s in sharp contrast to the travails facing European banks, notably in Italy.

While banks are being negatively impacted by zero interest rate policies of central banks, those that are based in the US are much better placed than their European peers which are grappling with non-performing loans and anaemic economic expansion.

From a political stand point, the US is also more attractive than Europe. It is very unlikely that the US will ever face the prospect of a break-up, whereas Europe is currently experiencing the upheaval of a likely exit of Britain from the EU.

With the likelihood of Donald Trump being elected president slipping in recent weeks, the risk of a significant change in political governance of the country is reduced.

The same cannot be said for Europe, where recent elections have seen increases in support for right-wing parties. Several important elections take place across the region over the next 12 months.

It is also likely that the dollar will strengthen from current levels given that the Federal Reserve is best placed among global central banks to continue the process of raising rates from all-time low levels.

This dynamic is likely to come at a time when the ECB will want to reduce the value of the euro in order to benefit European exporters. In Japan, further monetary stimulus appears very likely.

Should the move towards a more right-wing political establish itself during upcoming elections, there would likely be more downward pressure on the euro against the dollar, benefiting dollar investments made by investors.

Overall, despite the elevated nature of the US valuations relation to Europe, the former is an attractive alternative that offers investors less political and systemic financial risks.

  • David Holohan is chief investment officer at Merrion Capital


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