Conventional wisdom dictates that the US is the most efficient and most watched equity market, all the information is priced in and it’s hard to beat, therefore investors would be better off with a cheap, efficient passive fund.
However, the US isn’t as efficient as it is purported to be and high-quality companies, in particular, are often mispriced, according to George Dent, a client investment manager at Walter Scott.
During market downturns, everything sells off at the same time in the US, whereas in Europe, resilient companies with strong balance sheets tend to hold up better than competitors, said Dent.
“The one market that jumps out as being relatively inefficient – and it surprises people – is the US. When markets panic, the US panics more uniformly,” he explained.
“The upshot for us is that quite often when you get these big pullbacks, it’s the US where we’re finding opportunities.”
Mick Dillon, who manages Brown Advisory Global Leaders, agreed. In smaller markets such as France, Germany or his native Australia, there are fewer quality names. German businesses such as Deutsche Börse, software specialist SAP and the architectural software provider Nemetschek Group stand out and are valued at a premium.
By contrast, “there is a preponderance of quality within the US market” so these companies are not seen as prized assets and they get dragged down with the broader market.
Furthermore, the US market is heavily swayed by whatever the current narrative is, be it interest rates or artificial intelligence, Dillon said, and this dynamic is another source of mispricing.
For example, when Donald Trump was elected president in November 2016 until the end of that year, technology sold off because Trump was expected to regulate the sector.
Brown Advisory has a rule that if a stock falls 20%, portfolio managers must conduct a drawdown review and either buy more or get out. In the eight-week period after Trump was elected, Dillon was obliged to do drawdown reviews on Microsoft, Google and several other holdings. He bought more and benefitted from strong performance in the tech sector in 2017 and 2018.
Gerrit Smit, who manages Stonehage Fleming Global Best Ideas Equity, said the US stock market usually falls further than the UK and Europe (by about 2-6%) and it falls faster but recovers quicker. This happened during the financial crisis, the Covid pandemic and the aggressive tightening cycle of 2022, the FE fundinfo Alpha Manager said.
He attributes this to the sheer size of the American stock market, the huge waves of inflows and outflows, as well as the participation of enormous hedge funds. Then there is the growing cohort of passive investors who buy or sell the whole market “indiscriminately” rather than discerning between individual stocks.
All three managers use downturns as an opportunity to invest in high-quality growth businesses on their watch lists at attractive valuations.
In March 2022, Dillon bought two new investments on the same day – the only time he has done so in a decade. Ratings agency Moody’s, which he had owned before, and technology firm ASML, which he wanted to own for a long time, had both sold off significantly amidst concerns about war in Ukraine and high inflation.
When Covid-19 struck, Brown Advisory Global Leaders brought three US companies in the space of two weeks – adding software developers Autodesk, Intuit and AspenTech in the last week of March and the first week of April 2020. The fund usually has low turnover of about 10% annually and only added two new names in the 18 months before the pandemic.
“When we put Aspen on our ready-to-buy list, we put it on with a [note saying] ‘we’re going to buy this if it falls 50%’”, Dillon said, which is exactly what happened at the outbreak of the pandemic.
Previously, when the market tanked in December 2018 and the first week of January 2019, he added to his position in Visa.
A decade earlier, in the wake of the global financial crisis, Walter Scott made a big shift towards the US. “Some of the key US equity names we added to the portfolio in 2009 included Adobe, Amphenol, Nike and Mastercard,” said Dent, who is part of the investment team managing the BNY Mellon Long-Term Global Equity fund.
Walter Scott had been monitoring some of these businesses for years and was waiting for an appropriate time to initiate positions.
“We also seized an opportunity to invest in Google in 2010 when the US market panicked over the company’s ‘cost-per-click’ dynamics,” he continued.
Although the US equity market may not be as efficient as popular wisdom dictates, US indices have nonetheless been hard to beat. Dent said this is because of their concentration, not their efficiency. The largest stocks in US indices – the Magnificent Seven – have performed extraordinarily well and active managers, many of whom are reluctant to mimic the index and to allocate such high weightings to their benchmark’s largest positions, have fallen behind.
“It feels very unnatural having high single-digit weights in stocks and yet that’s probably what you had to do to meaningfully outperform the US market over the past 10 years,” Dent said.
Despite that, “as soon as you move away from the stocks hitting the headlines”, the US has some “fantastic businesses that aren’t particularly expensive for the growth and consistency on offer”.