The Great American Stock Market Dream

For most retail investors, the American stock markets have always been a mysterious dream. For a lot of them, holding stock in global behemoths like Facebook, Amazon, Coca Cola, Alphabet, Microsoft, Tesla and Intel can sound an extremely interesting proposition. Over the last 90 days, the American stock markets have risen 45 per cent after their March 23 lows. This rise is on the back of a bullish outlook with easy liquidity, re-opening of the US economy and a very strong degree of belief that the US economy will bounce back much earlier than expected. 

However, the popular American press has been inundated with reports of an upcoming recession, overvalued capital markets and the need to preserve cash given the aftermath of COVID-19. This asset class has started becoming important now as returns from other asset classes like equity and bank deposits have shrunk considerably. 

This article explores if it makes sense investing in the American stock markets. 

Over the last decade, the American stock markets have outperformed most other asset classes 

The American stock markets are tracked by the index scores of Standard & Poor (S&P) 500, NASDAQ and Dow Jones Industrial Average (DJIA). Over the last 10 years, the S&P 500 has generated an annual return of ~15 per cent while the Indian stock market has returned between 8 - 10 per cent depending on the segment. During the last five years, the NASDAQ has generated a return of ~21 per cent while the Indian stock markets are hovering in mid to high single digits. A lot of these gains have been generated with the 4 big tech majors (Amazon, Flipkart, Alphabet and Microsoft). 

In addition, the gains are more pronounced due to currency gain as the Rupee has slipped against the dollar from ~45 in 2010 to ~75 in 2020. In fact, no other asset class available in India, has generated returns along this scale of magnitude. 

The long term outlook of the US economy is strong and they are likely to dominate the next decade 

Deciding to invest in the American stock markets is akin to placing a bet on the long term health of the American economy. Over the next decade, the outlook on the American economy is very strong. Despite its often mentioned stagnation, its existing scale, its political dominance, American behemoths dominating major markets in emerging Asian and African economies, its ability to innovate and protection of intellectual property along with control over the global seas positions it in an enviable position. Given the anti-China backlash, any movement of companies outside China is likely to benefit America directly or their companies operating in emerging Asian companies. 

The tech behemoths constitute over 40 per cent of the NASDAQ index. Despite the talk of anti-trust motions and inability to censor online hatred, their long term outlook is extremely strong. For instance, despite global consumer oriented players choosing to stay off Facebook because of its limited ability to control online hatred, its revenue is likely to take a minor blip as nearly 85 per cent of its advertisers are small and medium businesses. With many countries banning Chinese apps (e.g. Tik Tok) and hardware players (e.g. Huawei), the four technology giants are likely to further capture share. In addition, the American tech majors have started partnering with leading conglomerates in large markets like India (e.g. Facebook and Google with Reliance, Amazon with Future Retail) to further capture disproportionate share going forward and avoiding anti-trust lenses. 

As a result, everyone should allocate 5 - 10 per cent of their portfolio, if not more, to the American stock markets 

Given the long term potential of the American economy and its past track record of producing sound returns, there is merit for most retail investors allocating 5 - 10 per cent, if not more, to the American stock markets. With a correlation coefficient of less than 40 per cent, the American stock markets have shown moderately less correlation with the Indian stock markets proving to be an able diversification asset class. In addition, with the long term outlook of the Rupee being close to 100 to the dollar, there is currency appreciation that is also likely to be generated. 

The best way to invest in the American stock markets is to go through mutual funds that invest on your behalf. Most major fund houses (e.g. Motilal Oswal, Franklin Templeton, ICICI) have mutual funds dedicated to the American stock markets. While choosing a fund, it is sensible to invest in a passively managed ETF to minimise fund management expenses as actively managed funds rarely generate incremental returns (alpha) in case of large cap funds. It is advisable to hold these investments for at least 3 years to realise the benefits of taxation. After a period of 3 years, the capital gains tax amounts to ~10 per cent (20 per cent - indexation benefits).  

 Source: Secondary research 

Now is not the right time to invest in the US markets. It is best advisable to wait for a month after the US Presidential elections to start investing

 A record percentage of money managers, as part of the Bank of America Global Fund Manager survey, believe that the American stock markets are significantly overvalued. The markets have scaled record high PEs (e.g. the S&P 500 12 month trailing PE is 26 which is nearly the highest in 2 decades) over the last month. This optimism is on the back of an expected V shaped recovery in the US economy along with continued support by the US government and Federal Reserve. 

Due to the insanely high valuations and lack of clarity in the Presidential elections and control over the COVID outbreak, it is advisable to wait for a month after the Presidential elections to get better visibility into government policy, COVID aftermath and hopefully more sensible valuations. However, if you plan to stay invested for more than 5 years, you shouldn’t bother too much and start investing now. 

In conclusion, allocating 5 - 10 per cent of your entire portfolio to the American stock markets is a no-brainer. In terms of mode, it is best advisable to go through the passively operated ETF route to save on costs and hold a fair proportion of the American bluechips. Although it is best advisable to wait for a month after the American Presidential election to get more clarity before investing. 

After all, Uncle Sam generates monetary happiness! 

The author is Director with Pricewaterhouse Coopers