Post-Budget and US election - is it time to invest again?

Important information – the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

Data excludes 2001 to 2002 due to Senator Jeffords changing parties in 2001. Calendar year performance from 1933 through 2022. Source: Strategas Research Partners, as of November 5, 2023.

On the basis of that, it makes sense for investors to look elsewhere for clues to the future performance of markets.

Tune out of short-term noise and in to long-term measures

No one knows for sure what will happen in the future - investments can go down as well as up - but investors can make judgements about the strength of the fundamentals that underpin markets. That means looking at valuations and the earnings prospects for companies.

Analysts at Goldman Sachs did this recently looking specifically at the US market, which is not the whole stock market universe, of course, but by far the biggest component of it. They concluded that the US market could have further to go in the near term, with a target level for the S&P 500 index of 6,300 in 12 months’ time, some 7% above its level today.¹

However, they then forecast that returns would begin to level out with the annualised rate of return over the next 10 years amounting to just 3%.

What’s holding the market back, they said, is its current high valuation - around 30 times price-to-earnings - and the fact that a lot of the value and returns have come from a concentrated group of very large companies.

That’s backed up in separate research by asset manager Schroders. It showed that the US market is priced at around 35 times its cyclically-adjusted earnings, or CAPE. (This is a metric which uses longer-term data to produce a more stable valuation). That is 39% above its 15-year average.²

Moreover, the Schroders analysis showed that the fact so much of the US market is concentrated in a small number of very large companies - those ‘Magnificent 7’ tech stocks - holds risks for investors. Specifically, it showed that there have only been eight instances in the past 20 years of US companies featuring in the top 10 performers in consecutive years, meaning the companies that have driven returns this year are statistically unlikely to do so again next year. 

Taken together, these factors make the case that relying on the same companies and the same region to drive returns is unlikely to work. But does that mean investors can’t find other pockets of performance?

The search for value

While the US market, and the biggest companies in it, have been driven to high valuations, other regions and sectors look more reasonably priced.

While US companies have a CAPE ratio of around 35 times, the rest of the world looks much more reasonably priced, as seen in the table below.

Source: Schroders Equity Lens - October 2024 

That’s no guarantee that these alternative regions will perform better, only that there is more room for growth away from America, based on valuations.

For those wondering whether to commit more money to stock markets now, the outlook is mixed. As always, there’s always potential reasons not to invest if you look for them. Valuations on the biggest companies in the biggest market - which have accounted for a lot of the stock market’s recent gains - look stretched.

However, other regions and smaller companies are more reasonably priced. Those investing on a value basis would look to skew away from the US, and within the US to smaller companies.

What about tax? Budget aftermath

The other event making investors uneasy has been the UK’s Autumn Budget, and the threats of a tax-grab from savers and investors.

As it turned out those fears were mostly unfounded. There was no reform of Pensions Tax Relief or the tax-free cash available from pensions. A rumoured rise in Capital Gains Tax (CGT) did arrive but was less severe than some feared. Some had forecast CGT could rise to the same rate as Income Tax but instead gains on investments for higher rate taxpayers rose by much less, from 20% to 24% - the existing rate for investment property gains.

The one headache for investors - for those wealthy enough to be impacted - was the plan to include pensions within the scope of Inheritance Tax (IHT). This change is not scheduled until 2027 but could alter the retirement income plans of those affected because they will no longer be able to preserve pension savings knowing they can be passed on without IHT applying.

• Listen to our latest podcast on how markets’ responded to Trump’s victory
• Read more on the new ‘double tax’ on inherited pensions

Source:

¹ Goldman Sachs - 25 October 2024
^2,3 Schroders Equity Lens - October 2024