The US election equity rollercoaster ride and where to go from here

The rollercoaster ride that has been 2020 is no better reflected than in the equity market, which has achieved record highs in the US but also plumbed bear market depths globally in March before mounting a steady recovery for the ensuing five months.

For much of the year, the prevailing concern has been the increasing divergence of the US stock market from the difficult economic realities as a result of the coronavirus crisis. In September, it appeared that reality was at last catching up, but stock markets rebounded again into October, when the S&P 500 almost reached its September record high again. However, the rally was cut short by new waves of Covid infections, the devastating implications these could have on recovering, yet still fragile, economies and pre-US election jitters.

Ed Yardeni has tracked the stock markets for decades and has identified the “panic attacks” that have sent equities tumbling. He puts the number of panic attacks since the financial crisis at 67, of which there have been two this year, namely the onset of the coronavirus in the first quarter and what he calls an overvaluation correction, combined with election jitters, in early September.

Within the next week, we will know whether the US elections are the third panic attack of 2020. It didn’t look like it the day of the election, as stocks rallied after pulling back into month-end, but most institutional investors were still unwilling to bet on the outcome, and had a wait-and-see approach.

There is an emerging view, however, that investors are gearing up for a rotation out of the big US tech stocks that have underpinned the strong equity market performance this year and into other geographic and market segments that have more to offer.

A lot of attention has been given to the bifurcation of the US tech stocks and the rest of the counters listed on the stock market. However, the divergent performance between the US and Europe has been extreme.

Schroders Quantitative Equity Fund Manager Daniel Woodbridge believes that after the extended outperformance of US growth stocks, this may be “not the worst time” to diversify outside the US. Woodbridge says: “It may not seem like it right now but international equities have regularly outperformed the US for significant periods of time. They also offer diversification.”

Among the reasons for diversifying now are that US mega-cap tech stocks are “richly” valued and vulnerable to disappointment. Also, international equities, particularly value stocks, “are offering record discounts to their benchmarks and appear to be in a zone that could be considered mispriced”.

It lists reasons to diversify internationally, including the usual suspects like getting broader regional and geopolitical exposure and access to faster-growing populations in Asia and other emerging markets. Most compelling currently, however, are the following:

1. Valuations are far more attractive, “even when adjusted for comparably lower growth rates”.

2. International diversification comes with exposure to other currencies.

3. Investors get exposure to less concentrated markets and greater opportunities for active investors.

JP Morgan Asset Management Global Head of Equities Paul Quinsee agrees there is a good chance that there will be better returns from a wider range of stocks because valuations do vary so much. “As the perceived winners have [become] expensive, though still supported by strong growth, we think investors should balance their portfolios and look for opportunities elsewhere in less expensive companies poised to benefit from a rebound in economic activity.”

Quinsee says his investors think the best of the market recovery is behind us. But he notes it is difficult to be too cautious, as the stock market stands to benefit from the highly supportive monetary conditions and optimism about a medical solution to the virus. He says the big debate in his team is about stock selection rather than market direction.

If stock selection is the way to go, Schroders says it may be time to take advantage of the substantial valuation gap between value stocks and the overall market – and international value stocks, not just US value stocks.

Schroders believes that ex-US equities “could be an interesting space to add exposure” and that considering international value-style equities would also allow you to “diversify away from the rich valuations of the US market and declining US dollar”.

There are certain underlying realities in stock markets that history has shown us they do eventually reassert themselves – often taking investors by surprise. With that in mind, the arguments in favour of international diversification and taking advantage of the valuations offered by currently unfavoured shares are convincing ones.