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Will Wall Street crash or crash through?

Anthony Fensom  |  01 Jun 2017Text size  Decrease  Increase  |  

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Regardless of whether the US market continues its bull run, diversifying internationally will likely remain an appealing prospect for Australian investors.

 

US stocks have hit new highs in 2017, with investors cheering strong corporate earnings and the prospect of corporate tax cuts under "Trumponomics". After an eight-year bull run, can the party continue or will the music stop?

On Friday 26 May, the benchmark S&P 500 marked its 20th record high for the year, surpassing the records set in 2016 on the back of double-digit gains in major technology stocks. Not to be outdone, the technology-heavy Nasdaq Composite has posted 35 record closes of its own in 2017.

The US bourse's post-GFC rally has continued to pick up steam, despite the prospects of higher US interest rates and worries over the longevity of the Trump administration.

As of the close of trade on 26 May, the Dow Jones Industrial Average was near its year-high at 21,070, up nearly 21 per cent over the past year, while the broader S&P 500 was up 17.5 per cent and the Nasdaq an impressive 27 per cent.

"With earnings growth expected to continue the rest of the year, it might be a rocky road but it could still be that the bull market makes it to nine," market strategist Ryan Detrick told Reuters.

"All hell will break loose"

However, not all analysts are convinced that the bull market will last forever.

On 17 May, US stocks suffered their biggest losses in eight months on concerns over the potential impeachment of President Trump, which could threaten plans for increased infrastructure spending, tax cuts, and regulatory reform.

Morningstar's head of equities research, Peter Warnes pointed to a warning by hedge fund Bridgewater Associates that impeachment could cause a 10 per cent fall in the US market--"the effective unwind of the Trump trade".

New York hedge fund Elliott Management has warned that "all hell will break loose" in US financial markets, including the risk of a recession in the world's biggest economy, should Trump's agenda be derailed.

The proportion of short sellers in the US market has hit its highest level since November, rising to 3.9 per cent of all shares outstanding, amid equity valuations "not seen since the dot-com era".

According to Bloomberg, investors withdrew US$20 billion (A$27 billion) from US exchange-traded funds and mutual funds in the latest quarter, reversing about one third of the inflows seen between November and March.

Glenn Rushton, executive director of Rushton Financial Services, noted long-term US data showing a bear market occurs once every 3.5 years, with an average fall of 35 per cent. Given the likelihood of flow-on effects to other international markets, including Australia's, "such a plunge would hit the retirement savings of millions of Australian investors," he said.

Yet, others point to more reassuring signs, including rising US and global economic growth and cautious rate rises by the Fed.

"It seems likely that the Fed will hike rates further this year and Wall Street will continue to be underpinned by solid corporate earnings," BetaShares chief economist David Bassanese said.

Trading US markets

For Australian investors, the US market offers both international and sector diversification benefits, given the small size of the Australian Securities Exchange and the local bourse's heavy weighting towards financials and resource stocks.

Jon Howie, head of ETF provider iShares, points out that the ASX represents around 2 per cent of the global market compared to the around 50 per cent weighting of US stocks, while the US bourse has major technology and consumer discretionary components, with stocks such as Apple, Facebook, and Johnson & Johnson.

The fund manager has five US-focused ETFs, including the iShares S&P 500 ETF (ASX: IVV), the largest such ETF on the ASX, as well as ETFs tracking US small and mid-cap stocks, and a hedged US fund.

"IVV is the lowest-cost ETF available on the ASX at just 4 basis points per annum, tracking the S&P 500, which is the most widely used equity benchmark in the world. It's an incredibly cost-effective way for Australian investors to get access to this broadly used benchmark," Howie said.

As of 30 April, IVV had a one-year total return of 20.27 per cent and a five-year return of 21.38 per cent, reflecting the US bull market and favourable currency movements. The iShares Russell 2000 ETF (ASX: IRU), which tracks the small-cap Russell 2000 Index, has posted a one-year total return of 28.23 per cent.

Howie said iShares had been a beneficiary of the rapid growth of Australia's ETF sector. According to Morningstar data, the sector has seen a five-fold rise in assets under management over the past five years, reaching $27 billion at the end of March 2017.

"Interestingly, we saw a slowdown in inflows around the US elections at the end of last year, indicating a degree of caution, although inflows have picked up strongly in the past three months," he said.

It is also possible for Australian investors to trade US stocks directly, although there are currency and taxation issues to address, along with the time difference in trading hours. According to CommSec, Australian investors buying US shares are required to complete a US tax form, with a 15 per cent tax on dividend proceeds.

Should the dire warnings of a US stock-market crash prove accurate, Australian investors could consider alternative investments such as gold and gold-related ETFs, according to BetaShares.

However, if the "Trump trade" survives, the fund manager suggests currency-hedged Japanese equities via the Betashares Wisdomtree Japan ETF (ASX: HJPN), the US dollar via the Betashares US Dollar ETF (ASX: USD), or the BetaShares Nasdaq 100 ETF (ASX: NDQ).

Yet, crash or no crash, diversifying internationally and earning a slice of global giants such as Google will likely remain an appealing prospect for investors, particularly with the Australian market's relatively sluggish recent performance.

And thanks to the power of the internet, including Morningstar's international coverage, staying in touch with Wall Street has never been easier.

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.