Pain priced in or just deferred? Why investors shouldn’t be enticed back to US equities yet

Valuations in the US provide an insufficient margin of safety, and investors should not be enticed into buying equities at these levels with so much uncertainty, believes RWC Partners’ Clark Fenton.

Emergency measures from the authorities in the US have been cheered by investors, causing a bounce back for the S&P 500 and other US indices, with the S&P 500 now down 11% year-to-date when it had been off more than 30% at the low point.

But Fenton, manager of the RWC Diversified Return fund, said while the rally has left the S&P 500 close to pre-crisis levels, the rally could be short-lived, with the US Federal Reserve merely preventing an insolvency event so far.

“We are not out of the woods yet for risk assets, not by a long way,” he said.

“What we’ve had so far is a big liquidity response to prevent a complete tailspin for markets. That has worked, but there’s still so much insolvency risk out there, not only from companies but also the longer-term impacts of this as it changes our behaviours.”

As a result, now is not the time to buy equities, like it was during the sell-off that followed the 2008 financial crisis, he says, with potentially more pain to come and fresh lows for the S&P 500 and other indices.

“If you look at the S&P 500 now, it doesn’t feel like these longer-term risks are priced in at all,” he said.

“There are so many unknowns, with many companies not issuing guidance, so all you can do on an individual-stock level is ask what is already in the price, and for a lot of stocks it simply looks too early to make a move back in.”

Fenton said on a technical level, there are even more reasons to be cautious now, with the recent rally taking the S&P 500 to an all-time high on a price to GDP ratio.

“The S&P 500 is still at a record high on some measures, such as price to GDP, and that is a warning sign, especially when we have not progressed to a more sustainable phase of the credit cycle, with companies carrying a lot of debt and adding more,” he said.

“Until we see the longer-term impact of the virus on the economy and real balance-sheet repair, we can’t be sure we are near the bottom. Liquidity provision and more debt are simply not enough”