Why US market's still best of bad global lot

Defensive quality of American stocks cited among reasons for their attractiveness

 06 Jun 2012 10:05

[NEW YORK] EUROPE'S worsening debt crisis and the sharper-than-expected slowdown in China have weighed down stocks since the start of April. Yet some market strategists say that so long as these overseas fears don't morph into another global panic, they could serve another purpose: to remind investors that the domestic stock market may be the best choice among a tough set of options.

This may seem a difficult statement to make, after Friday's disappointing jobs report, which showed that the domestic economy produced just 69,000 new jobs in May, roughly 90,000 fewer than were expected. The bad news sent the Standard & Poor's 500-stock index down by 2.5 per cent on Friday.

Yet even with the losses, the S&P 500 is still up nearly 2 per cent for the year. The Morgan Stanley Capital International Emerging Markets index, meanwhile, is down more than one per cent, and the MSCI EAFE index of foreign stocks in the developed world is off nearly 6 per cent.

This performance mirrors a similar pattern since the autumn of 2009, when signs of the European debt crisis began to emerge. The Leuthold Group studied the performance of 49 major stock markets since October 2009 and found that stocks in the United States outperformed those of 40 other countries - many by a wide margin. And of the eight nations whose markets beat the US, only South Korea is part of the developed world.

Duncan Richardson, chief equity investment officer at Eaton Vance, noted that the jobs report was certainly a setback for the economy. "But jobs are always a lagging indicator," he said. "And one number is not going to change the relative attractiveness of the United States over other regions."

Mark Luschini, chief investment strategist at Janney Montgomery Scott, agreed. "I still think that on a relative basis, the defensive quality of US stocks makes them attractive," he said, adding that domestic shares have at least two other things going for them.

First, "they're backed by an economy that, while hardly vigorous, is at least showing signs of sustainability", Mr Luschini said. Much of the rest of the developed world, of course, cannot make such a claim right now.

Indeed, while gross domestic product (GDP) in the US is expected to expand just 2.2 per cent this year, growth is expected to accelerate to 2.4 per cent next year and 3.4 per cent in 2014, according to IHS Global Insight. Many parts of Europe, meanwhile, are already in recession, and the GDP in the eurozone isn't expected to reach a 2 per cent annual growth pace until 2016. And while growth in Japan is running slightly ahead of the US this year, the Japanese economy is expected to decelerate for the remainder of the decade.

Second, the domestic market also benefits from strong corporate balance sheets, relative to those from overseas. Companies in the S&P 500, for instance, are often sitting on record amounts of cash and are generating record profits, with better-than-expected first-quarter results. To be sure, global uncertainties may be weighing on the job market.

"Corporations are profitable and have billions in cash, but the lack of visibility in their operations due to what's going on globally is making them reluctant to hire," Mr Luschini said. And if Europe's troubles worsen drastically, stock markets around the world are likely to fall in lock step, which was evident last week.

"Unfortunately, in a true crisis, it's hard for individual equity markets to differentiate themselves as safe havens," Mr Richardson said. "But in an environment marked by less panic, there is the potential for the US market to decouple somewhat from the direction of other equities."

Mr Richardson sees at least two big fundamental factors that are likely to drive investor interest to the US. First, "there's the state of US banks", he said, noting that they have done a much better job of recapitalising than their European counterparts after the 2008 financial crisis.

Moreover, he said, "the housing market here continues to show strong signs of bottoming, which would be very encouraging since housing drives so much of the other parts of the economy".

At the same time, a couple of side effects from the slowdown in China and Europe could also benefit domestic equities, market strategists say. For starters, crude oil prices have fallen in recent weeks, partly because of renewed worry about the global recovery. After peaking above US$108 a barrel in March, West Texas Intermediate crude oil fell to US$83 last week.

"That should help keep the consumer in the game," Mr Richardson said.

The woes in Europe and China have also added to investor fears, which, in a contrarian way, may be a positive sign for domestic stocks, said Doug Ramsey, Leuthold's chief investment officer. He noted that the Yale Crash Confidence index recently fell to an unusually low reading of around 25, down from 37 a year ago and 57 in 2007, before the financial crisis.

The decline would indicate that a large number of institutional investors fear that stocks could suffer a big setback in the coming six months. - NYT