Why we are ‘short’ the US
Donald Trump’s election has put the fire in the belly of the US stock market. Investors have become excited about the dealmakers in his administration and the plans to cut taxes and spend big on roads and other infrastructure projects.
James Clunie, Head of Strategy, Jupiter Absolute Return.
The likely flipside of rampant government spending is higher inflation and interest rates. But judging by the stock market’s response to the recent interest rate rise by the US central bank, the Federal Reserve (the “Fed”), people seem pretty convinced Trump’s pro-growth agenda will outdo those risks.
Never before has the S&P 500 Index, the main yardstick of the US bourse, been at such dizzying heights. Of course the nominal value of the index alone is not a great measure of whether the US stock market is cheap or expensive. But other respected valuation measures suggest the easy money has probably been made since the current rally started in 2009.
‘never before has the S&P 500 Index been at such dizzying heights’
One example is the cyclical adjusted price-to-earnings ratio (“CAPE”). CAPE is a tool of finding out if the market seems cheap or expensive by comparing long term ‘real’ earnings to stock prices.
The current CAPE score for the S&P 500 Index is 29.8 – high compared to history. It has only been higher in 1929 and at the peak of the dot.com boom in 1999, since the 1880s (see the chart below).
Seasoned investors will know that market barometers like this help to take today’s temperature, not tomorrow’s. And CAPE is an average measure. There are still pockets of value, just as there are pockets of excess. But statistically speaking, the higher stock markets move away from the CAPE’s long-term average, the greater the chance of heavy weather ahead.
Evaluating policy is a balancing act, and is one we typically avoid when managing our strategy. For us, there is no advantage in trying to second guess the next move of politicians. We consider ourselves skilled in picking ‘long’ and ‘short’ stock opportunities for Jupiter’s absolute return strategy. We remain aware of policy from a risk management point of view and to help build robustness in our strategy, but try not to use it as a starting point for our investments.
S&P 500 Index CAPE and 10 year US government bonds
Chart source: http://www.econ.yale.edu/~shiller/data/ie_data.xls
To quickly explain long and short investing. When you buy – or go ‘long’ – a stock, you are effectively expressing a view about the future prospects about that stock. You seek to gain from the value of the stock going up and any dividends (a share of the company’s profits distributed to shareholders) you might accrue along the way.
Taking a short position is the opposite. You are expressing a negative view about the stock price and seek to make money from its value going down. There might be signs of problems at the business that appear out of sync with a high stock price.
But it’s quite possible for a good business with solid cash flows, i.e. money coming in and leaving the business, to become overpriced and a bad investment. Being able to short allows us to try to tap into those opportunities. Of course, as with all investing, things may not work out as planned and with short-selling potential losses are theoretically unlimited.
At 21%, the strategy’s short position in the US is one of the largest country risk exposures we have at the moment. Why? Well our reason essentially boils down to the strength of the opportunities we have been finding in that market. A number of stock prices seem too high to us and appear to have catalysts for a change in fortunes.
‘the strategy’s short position in the US is one of the largest country risk exposures we have’
In the US we expressed negative views on some global industrial and well-known food companies that are considered high quality and “safe” by many, but actually appear expensive and risky to us. It is not comfortable to short these companies given some investors can be attracted to their perceived safety at whatever cost. But their prices leave little room for unexpected news that could easily upset the applecart.
We are also finding many so called ‘glamour stocks’ which have exciting investment stories – innovative products, business models or star entrepreneurs – whose prospects have been propped up by creative financing that has left some balance sheets looking unhealthy.
One consequence of low interest rates and rising stock markets is that companies have been able to borrow money cheaply. This has led some management teams to become hubristic and some investors to become complacent. Companies with little wriggle room when it comes to their debts are likely to struggle if US interest rates continue to rise. We have shorted social media, technology and pharmaceutical stocks that have this quality.
We haven’t bet the house on the US going down. In fact, we are being very selective. And in the portfolio we have roughly the same amount invested in long positions as short positions, which means the strategy should make or lose money based on the relative price moves of individual stocks it invests in rather than whether the market as a whole goes up or down.
But the fact that our short exposure the US is currently the largest in the strategy may say something about the broader valuation of that market. In the fullness of time, elevated stock prices and rising interest rates might be the deciding factors that keep the Trump enthusiasm in check.
As with any investment, market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.
Absolute Return: In fund management speak, ‘absolute return’ simply means the actual increase or decrease in an investment, as opposed to how an investment fund might perform relative to a benchmark like a stock market index or cash rates. As such, absolute return funds typically seek to generate positive returns (over a certain period) regardless of whether the market is trending up or down. This is no mean feat.
Long position: Buying a security with the expectation that it will deliver a positive return if its value goes up or a negative return if its value falls.
Short-selling: Short selling involves the sale of an asset that has been borrowed from a third party with the intention of buying the asset at a lower price at a later date. It is a way of making a profit when the price of a security falls.
Bonds: A kind of debt issued by a company (corporate bond), government (sovereign/government bond) or other institution in order to raise money. In most cases, bonds pay a fixed interest rate over a fixed period of time and will be repaid on a particular date.
This article is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. Past performance is no guide to the future.
The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request.
The views expressed are those of the fund manager at the time of writing (April 2017), are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority.
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