Question 1: Will the performance gap between the U.S. and the rest of the world ever close?
The truth is we can’t predict when the gap will close, but we don’t think we need to know this to take advantage of the market imbalance. It is no surprise that U.S. stocks have delivered phenomenal returns over the last decade or so— outperforming non-U.S. stocks in 10 of the past 12 years—with low interest rates, a pro-business environment, and tax cuts often cited as performance drivers. Yet, with sentimental strength comes consequences. As price growth has exceeded the underlying fundamental growth of these companies, it is natural that investors will eventually need to taper back their expectations on the U.S. market. We believe this could lead to capital being allocated away from the U.S. into previously unloved markets.
Source: Morningstar Investment Management calculation, Morningstar Direct data to 31 August 2019. Past performance is not a guide to future returns. Figures in percentages.
To be clear, we have no insight on when a reversal might happen but prefer to limit exposure to such risks. One way of expressing this is by holding less in expensive asset classes (including the U.S.) and allocate to cheaper asset classes such as the U.K., Japan, and emerging markets. We believe by doing so, we’re holding assets that generally have more room to grow and less room to fall. Over a full market cycle, research suggests this approach should deliver stronger returns while giving investors a smoother ride. Again, we believe this smoother ride should help individuals stay invested, which in turn should lead to better outcomes and ultimately help people reach their goals.
Question 2: Why are you investing in the U.K.? Are you changing your conviction as the political and economic weakness evolves?
We believe the case for investing in the U.K. remains strong, especially in a relative sense.
Practically, we know investors shy away from uncertainty, which has impacted sentiment and will continue to do so—for a while. The fact you’re concerned about the U.K. shows that demand is impacted in the short term. However, we’d suggest you broaden your perspective when thinking about supply and demand. Ultimately, long-term demand is a function of the cashflows the underlying companies can produce, which in the case of the U.K., looks on a solid footing.
Fundamentally the U.K. economy is not the same as the U.K. equity market. In fact, over 70% of FTSE 100 companies (the 100 largest listed companies in the U.K.) derive their revenue offshore. Moreover, approximately 28% of these revenues are derived from emerging markets. Therefore, it is a mistake to think that buying U.K. stocks will give you exposure to the U.K. economy.
Empirically, we’d simply cite that the link between economic growth and investment returns is weak at best. So, yes—the U.K. economy could worsen, but that isn’t a basis for us to not to invest.
