Is it Time to Sell US Equites?

Federal Reserve chief Janet Yellen has said that US equities look fully valued and interest rates are due to rise imminently, should investors be curbing their US exposure?

Emma Wall 14 May, 2015 | 10:04AM
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Emma Wall: Hello and welcome to the Morningstar Investment Conference. I'm Emma Wall and I'm joined today by Cormac Weldon, Artemis U.S. Equity fund manager.

Hello Cormac.

Cormac Weldon: How are you?

Wall: Very well thank you. So we've had Janet Yellen come out and say that U.S. equities look fully valued and we've also heard you talk today in the Morningstar Investment Conference about how fundamentals seem to support interest rate rise, which could be bad for the market. So those two things combined, does it mean it's time to sell U.S. equities?

Weldon: Well, we don't think it time to sell U.S. equities. What we're pointing out is there are risks there. I think that's what Janet Yellen was doing. She was saying there, U.S. equities are somewhat fully valued. But we are living in very strange times, where relative to other asset classes we could justifiably argue that U.S. equities are cheap. So for instance, the same week that Yellen made that comment, we heard that the Swiss National Bank has been buying Apple (AAPL).

So we're living in strange times. Traditionally speaking, the first interest rate increase isn't really the time to sell the market. For instance, interest rates went up in '94. The bull market ended in 2000. That's the most obvious example obviously somewhat self-serving, but I think what it means is, the risks are somewhat higher and we need to be aware of those.

We need to be aware of emerging inflation, is there an inflation problem out there, that one might make us change our mind. We don't think there is. We think the biggest risk in the world is still deflation, although we are starting to see some wage inflation in the U.S. So it's flagging a risk, but it's not the end of the market.

Wall: And of course these fundamental changes don't necessarily mean bad new to the entire market. We heard Clive Beagles talk earlier about similar situation being created in the U.K. and he was saying bond proxy stocks are going to be hit hardest by interest rate rise, I presume it will be the same in the U.S?

Weldon: Yeah, we couldn't agree more. I mean really those stocks have been revalued higher and higher and higher, because they are bond proxies and because interest rates are low and people are looking for somewhere else to put their money to get a dividend. So within our funds for instance;  we are under weighed in utilities, we're under weighed in consumer staple stocks, REITs real estate investment trust, reasonable part of the especially the Small & Mid Cap index were also under weighed.

Other parts of the market, we just think the more cyclical parts of the market which are actually quite cheap, it should do better. We still like technology. There is good value there. I believe they are not on good growth which we think can come through irrespective of what's happening in interest rates. So we think the – we would agree, the interest rates signal and interest rate increases are important for how you structure your portfolio.

Wall: And what about the impact then on consumers, because wage inflation is obviously positive for consumers and therefore positive for domestically focused stocks, but then the flick of that is, if people are having to pay more on their mortgages, they have less money in their pocket.

Weldon: Yeah, that's true and that's really what Yellen has to judge because that's exactly the dynamic as wage inflation comes through, perhaps some consumer inflation will come through, people will be feeling pretty good about that. But is the mortgage going up, and obviously, we know mortgages are set by 10 year rates, not short-term rates, but nonetheless, the cost of money isn't zero anymore and that's a part what the Fed has to judge that we believe what they want to do now is to start raise interest rates, but not have a negative impact on the economy and that's a delicate balancing act.

Particularly today, where it seems people are very skittish about interest rates going up, but I think the important factor about all of this is, this has to be the most discussed interest rate increase in history, so that's good for market because we're discussing it about the impact to markets, it's also good for consumers. They are thinking do I borrow to bet, do I borrow to buy a home, do I take out a mortgage, interest rates are going up, CNBC is telling me that all day every day. So we think that just get factored into our expectations and therefore isn't the shock that perhaps sometimes we think it would be.

Wall: Cormac, thank you very much.

Weldon: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar