New era in US but investors can expect status quo to continue

Share investors need to reassess the balance between growth and value following the US election.

Coca-Cola is a takeover target as investors look for value. Picture: AFP

The US election result and the parallel rally on Wall Street indicates investors can expect a continuation of the status quo.

With the Republicans likely to take the US Senate, it is probable that for whoever wins the executive branch, the result will be gridlock; they won’t be able to substantially change anything.

In turn that means the positive conditions of monetary and fiscal stimulus will carry on. There is some questions about how things will play out in the medium term, but the assumption is that the handouts will continue at least early into 2021. The US Senate isn’t going to put up taxes and is going to be putting pressure on the executive (the President and the administration) and the congress to cut costs.

Clearly growth stocks such as small caps will continue to be favoured in the short to medium term, but long-term investors also need to be exposed to value — high-yielding stocks with low price-earning ratios, ideally coupled with stable earnings. Otherwise known as blue chips.

The importance of value is underlined by the attempted take­overs of two well-known market brands: AMP and Coca-Cola Amatil. Local investors are not the only ones looking for value!

Investors always need exposure to growth, which small cap stocks provide, because that is the way to build wealth. But you also need to be prepared to weather volatility, which is where earnings resilience and the resultant dividend income is important.

In the three months leading up to the US election, the US 10-year Treasury Bond had risen in yield from 0.5 per cent to 0.9 per cent. This might not seem much but it’s the valuation benchmark all assets are based on. It’s a big deal because high-risk assets such as growth stocks are vulnerable to any such increase in rates.

If you own a growth stock like Afterpay, your asset has a long duration. The cashflow upon which your valuation relies is seven to 10 years away at least. In a bond portfolio this is called duration.

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Short-duration assets are those where you’re earning more than 10 per cent of your returns this year. A high-duration portfolio is much more sensitive to changes in interest rates than a low-duration portfolio, which revolves around value.

Moreover, the Washington gridlock might work from a short-term point of view of not changing tax policy, but it doesn’t work for global investors, who want to see debt/budget situation addressed.

The risk is that the US government has to finance another $US10 trillion in debt.

There is potential for the US dollar to come under pressure and for the risk-free asset, US 10-year Treasuries, to sell off as inflation concerns re-emerge. Already the Australian dollar has moved up sharply against the greenback.

If you have the US long bond trading on a yield of 1.5 per cent, suddenly you have to worry about valuation again. Instead of there being no alternative to chasing yields in the sharemarket, suddenly you have a fixed interest candidate.

Growth is important but it isn’t everything in the markets, which is why the portfolio approach is crucial to building wealth.

Over time, the pendulum will swing back towards stocks that represent more certainty in earnings, which is where the value lies in many blue-chip stocks.

Richard Hemming is an independent analyst who edits undertheradarreport.com.au