The US stockmarket will present an attractive buying opportunity once the Federal Reserve completes its current phase of interest rate increases, according to Peter Kaye, manager of the Melchior North American Opportunities Fund for Dalton Strategic Partnership.
US equities are now at some of the cheapest levels seen in the last eight years and once the uncertainty and risk aversion created by rising interest rates is over, their prospects will become more favourable, he says.
The rise in US interest rates has prompted a round of “carry trades” unwinding over recent months. When interest rates were lower, investors found it profitable to borrow at the short end of the yield curve and invest in longer duration assets such as long-dated government bonds, credit, commodities and equities. But the rising interest rates have made the carry trade unprofitable and the leverage has been unwound. Equities have suffered despite an apparently favourable backdrop. This has pushed down the prices of American equities to the point that the price/earnings ratio of the S&P 500 Index now lies at around 15, compared with the mid-20s seen at the height of the bull market. This is despite the fact that earnings growth exceeded expectations in the first quarter of this year.
Kaye commented: “There will come a point in the medium term when the unwinding leverage and risk aversion has run its course and we approach the point at which the Federal Reserve has completed the phase of interest rate increases. When this time comes, the US equity market should present an attractive buying opportunity.”
Kaye, who has just returned from a trip to the US, believes the US’ bottom-up fundamentals are looking solid. Earnings growth may have slowed from the strong levels seen in 2004 but first-quarter 2005 earnings results delivered in April still outstripped expectations and showed that analysts were still being too pessimistic. US corporations are in top form with healthy balance sheets, strong levels of cash generation, good levels of revenue growth and strong margins. Current analyst estimates of 8% year-on-year growth in Q2 2005 appear to be too low, he says.