Small caps strong in the US
The American dream is still alive for investors, writes Macquarie NZ’s James Grigor.
In the latest Reserve Bank economic update, Governor Wheeler highlighted that prospects for growth in the global economy have diminished, and significant downside risks remain.
But for investors seeking growth, we remain positive on the prospects of the US economy. More specifically, US small cap equities (equities with a relatively small market capitalisation), should be sheltered from global risk on events such as the Brexit vote.
Why contemplate US small cap equities?
The current low interest rate environment in New Zealand has meant high dividend-paying NZ equities have performed extraordinarily well. The S&P/ NZX50 Gross Index is up 31 per cent in the last 12 months to the end of July. While this performance has been nothing short of outstanding, Macquarie Research’s view is that equity investors should now look to realise some of these profits.
US small caps are more insulated than large caps from weakening global demand, as approximately 80 per cent of their sales are leveraged to the growing US domestic economy. Macquarie Research has forecast the US economy will be strengthened by consumer spending, and we forecast personal consumption has risen in the US by approximately US$500 billion over the past 12 months. While US jobs growth has moderated, this is being more than offset by improving wage growth.
New Zealand investors moving money into US dollars will also take advantage of the strong New Zealand dollar. We expect the New Zealand dollar to weaken to a low of US$0.64 by the third quarter of 2017, providing more upside for any holding of US assets. Small caps do have higher risk Over the long-term, small caps have outperformed large caps in the US. However, small caps, due to their very nature, are more volatile. At the same time, small caps historically do not perform well during interest rate tightening cycles. While we only expect interest rates to increase gradually in the US, a more hawkish US Federal Reserve may put pressure on the US economy in future.
Despite the recent weakening, the New Zealand dollar has been stubbornly high and further strengthening will provide a headwind to any foreign currency investment.
How to access US small caps: For investors interested in accessing US small caps, a low cost and popular option is through Exchange Traded Funds (ETFs). ETFs offer diversified allocation while still providing sufficient liquidity for investors.
The views expressed in this article are those of Macquarie
Private Wealth New Zealand and may not constitute the views of the Macquarie Group. Macquarie Private Wealth’s services in New Zealand are provided by Macquarie Equities New Zealand Limited (MENZ), a NZX Advising Firm. The disclosure statement for MENZ is available free of charge on 0800 742 737.
This article is not investment advice and does not consider objectives or situation of any particular investor. We recommend that you consider the appropriateness of information to your situation and obtain financial, legal and taxation advice before making any financial investment decision.’’