US equities in a post-Brexit environment

Alec Harper, client portfolio manager at AXA Investment Managers Rosenberg Equities, discusses US equities in the aftermath of UK’s decision to leave the European Union (EU).

The surprise vote by the UK to leave the EU has been widely reported, as has the reaction by markets. The question no-one seems to have an answer to yet is, ‘what happens next’? With the UK political system in crisis and no sign that the all-important Article 50 will be invoked anytime soon, this presents a conundrum for investors.

Already we have seen equity indices in the UK recover much of the ground they lost in the immediate aftermath, but many European gauges remain underwater and currency movements are also having an appreciable impact on total returns. So where can equity investors find a relatively safe haven in the short term?

We recently issued a note that argued in favour of US equities, despite frequent accusations that the market is overvalued. In the note we outlined the case for why the US does, and should, command a valuation premium, certainly over and above markets such as Europe.

Structurally the US is dominated by global firms to which Europe has no answer (Alphabet, Apple, Amazon, Facebook, to name a few), something that was also critiqued in a recent article published by The Economist, citing that of the 50 most valuable firms in the world, 31 are American and only 7 are European.

Nonetheless, one fallout from the Brexit debacle is that safe-haven currencies such as the dollar have strengthened considerably, particularly against sterling, with some concern that this will have implications for the earnings of US companies.

While this may affect some businesses that have a global focus, concerns may be overdone: US corporates only earn 4% of their revenues from Western Europe, based on 10-K filings for 2014. In fact, US companies generate some 67% of their earnings domestically, which provides some insulation from global macro events.

At the same time, the aforementioned structural differences of corporate America from Europe mean that the earnings-per-share of US companies have historically been much less volatile than those in other markets.

With less financials and more cash generative technology stocks, the US equity market historically has also had a lower beta than global equity markets (0.95 for the 20 years to end June, monthly return of S&P 500 vs MSCI World Index).

What is more, the US has historically outperformed global markets in years of stress. The only outlier was 2002, which was attributable to the Enron and Worldcom scandals.

In summary, we believe that in the short term the US market could prove to be the best shelter for equity investors: a domestically focused corporate sector, historically less cyclical corporate earnings cycle and lower-beta price performance are all likely to be attractive qualities in what is likely to be a much more uncertain world.

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