The current US economic cycle will become the longest on record since the second world war, eclipsing the longest set in the 1990s, according to BMO Global Asset Management’s Paul Niven.
The manager of the four FE Crown-rated Foreign & Colonial Investment Trust said that while unprecedented monetary policy measures are nearing an end, the US market has more room to run.
“We are confident in the domestic situation in the US,” he explained. “We think that the US cycle is going to extend to the longest on record.”
During this period, the S&P 500 has entered its ninth year of consecutive growth, as the below chart shows, following on from the global financial crisis of 2008.
Performance of index over 10 calendar years
Source: FE Analytics
The reason behind this is that the economy is continuing to perform strongly, with leading indicators improving and corporate earnings also on the rise.
“The pace of upgrades in terms of earnings momentum is amongst the highest in recent records – we have had a 4 per cent rise in EPS [earnings per share] expectations in the US just over the course of the last five or six weeks,” the manager explained.
“A recession/downturn not imminent, the leading indicators are very supportive of ongoing expansion in the US.
“So that is a pretty good environment and one in which the corporate sector we think should continue to perform pretty well in.”
What could derail it is any deviation from current central bank policy, with the removal of quantitative easing (QE) measures and higher inflation raising some concerns among investors.
“It is obviously going to give rise to further rate rises, a reigning back of the US Fed’s balance sheet and that is going to have implications for markets in due course,” he said, adding that this will take time to filter through.
Niven said corporates often struggle because a lack of capacity and tight labour market lead to raising wages and inflation in such environments.
While this has happened in the past, he said the composition of the labour market, which is more fragmented and less unionised than it has been, will have a lesser impact today.
“Yes, it will have an impact on profit but it won’t have the impact that historically one might have expected. So, the outlook for the US economy is good and is on pretty robust footing,” he said.
However, what rising interest rates will bring with it volatility as tight credit spreads begin to unwind.
“You do tend to see equity markets continue to make progress but actually the gap between winners and losers begins to widen further,” he said.
As such, while some are concerned about valuations in the market after such a long bull run, Niven said there are no signs of excess just yet.
“My sense is that if you consider the anatomy of a bull market rather than a bear market – and people are continually looking for the end of this bull market – we do tend to reach a point of excess typically,” he said.
“I think there is a reasonable chance that we end up seeing higher levels of excess before the bull market is done than where we stand today.”
Although many are concerned by valuations, the manager said one area the £3.5bn investment trust has a big position in is the technology stocks– often the poster child for overvaluation.
Indeed, during the last five years of the bull market, the S&P 500 Information Technology sector has returned 186.32 per cent, while the S&P 500 index has returned 113.83 per cent.
Performance of indices over 5yrs
Source: FE Analytics
The manager said that despite a high weighting to the US and a positive outlook for the economy, much of his positioning is centred around the growth style and, in particular, companies termed disruptors.
“We do hold all the FAANGs [Facebook, Amazon, Apple, Netflix and Google’s parent company Alphabet] and we do hold Alibaba and Tencent as well,” Niven said.
“I think that valuation on Amazon, in particular, is extremely difficult as it has defied conventional wisdom in terms of valuation metrics for quite some time.
“But if you look at some of the other businesses whether it is Alphabet or Facebook they are now generating decent levels of free cashflow and are perhaps not as ridiculous as conventional wisdom would suggest.”
This is because, while the US economy is growing, it is becoming less dynamic, with higher barriers to entry creating greater dispersion between winners and losers.
“There is a real belief that the US economy is very dynamic, innovative and vibrant and actually on any number of metrics it is much less dynamic than it has been for a long period of time; this has been an ongoing trend,” he noted.
Indeed, productivity is low while corporate profit share of GDP is very high – something that market bears fear must correct at some point meaning that profits will fall and that the market is overvalued.
However, he said with labour pricing power much lower than it has been in the past and competitive barriers much higher, there are fewer new entrants and less entrepreneurism than one might expect.
“There is concern that Google is dominant in terms of search and Facebook is becoming dominant in terms of news [for example] but the point is that as companies’ positions become more entrenched it is harder for new entrants to compete and they get a dominant foothold,” he said.
“If you buy the notion that there are bigger barriers to entry in getting into industries and therefore that there are less companies competing, then it basically means that profitability levels are probably higher than they otherwise would be.
“There are also less employers and therefore labour has got less power and that arguably there is not going to be this mean reversion people expect.”
As such, large companies with pricing power and little competition are only likely to get stronger, he said, adding that this is happening across the market, not just in the tech space, although it is the sector gaining the most attention.
Niven has managed the Foreign & Colonial Investment Trust since 2014, during which time it has returned 85.62 per cent versus the IT Global sector’s 67.57 and FTSE All World benchmark’s 62.71 per cent.
Performance of fund vs sector and benchmark since manager start
Source: FE Analytics
The fund has a 48.4 per cent weighting to the US while just 5.5 per cent exposure to the UK after the manager made a decision to move away from a large home-bias overweight of around 33 per cent in 2013.
Its largest positions are Amazon, Microsoft and Alphabet, with Facebook, and Apple also sitting in the top 10 holdings.
The 150-year-old investment trust is 8 per cent geared and its shares are trading at a discount to net asset value (NAV) of 2.5 per cent, according to the Association of Investment Companies (AIC).
It has a dividend yield of 1.6 per cent having increased its pay-out for 46 consecutive years and ongoing charges of 0.54 per cent.