“New York doesn’t matter anymore.” A native European, now residing in Menlo Park, CA, and working at a technology startup, said this to me recently. New York doesn’t matter anymore?
I am from Boston, so I wasn’t raised to think New York was the center of the universe. Moreover, I am a rabid sports fan, so I revel in pointing out that this statement, “New York doesn’t matter anymore,” is factually correct applied to the National Football League. But, as far as cocktail banter goes, “New York doesn’t matter anymore” is very memorable.
Is this pervasive thinking? Was this a European using New York as an American microcosm in preferring Europe to the US? Or was this a Californian perspective, pumped up by Bay Area real-estate prices and private-equity tech valuations, feeling California is cool and New York is “over?” I didn’t get to the bottom of that in the brief conversation, but, either way, I object.
Europe vs. US
We think the US has many more attractively priced, high-quality, multinational growth companies, most of which, unlike in Europe, are not in the commodity complex or largely reliant on Chinese stimulus. Quantitative easing in Europe, something often offered as a key rationale to prefer European equities now, won’t be as effective as the US program because there is no mortgage-backed-securities equivalent in Europe, and that is what had the highest correlation to the S&P 500 during the Federal Reserve balance-sheet expansion.
US earnings are growing around 6%, excluding energy in 2015. Even assuming a strengthening dollar, we forecast 4% organic earnings-per-share growth for the S&P 500 in 2016. On top of that, we forecast a 2.2% net buyback (note: Europe is a net diluter of its share base) and a 1.9% dividend yield.
We think investors may look at the 8.1% total return potential for the S&P 500 in 2016 and decide that is quite attractive vs. other asset classes and other equity regions, including Europe. US corporate earnings are twice as high as they were six years ago, while European earnings haven’t really grown during this “expansion.”
Financials vs. Tech
Our portfolio has a large overweight in financials and has slightly less than the bench-weight in tech. In our view, financials are more than a call on the 10-year yield. Historically, banks outperformed when the dollar strengthened, as they are not typically subject to the currency issues of, say, many tech stocks, which have dramatically different revenue and cost profiles in Europe, relative to the US.
Moreover, the growth in shareholder return should be strong for the large banks, the result of another successful comprehensive review later this winter. Furthermore, banks simply make more money when the front-end moves, something that hasn’t been embedded in prices since Fed lift-off. Broadly, we don’t see that many industries with true margin expansion potential, above-average earnings growth, and valuation that is attractive relative to history.
Credit Where It’s Due
Credit-card companies also make a lot of sense. The US consumer has plenty of money, with housing and jobs both improving, and low gasoline prices increasing disposable income. Credit-card stocks are attractively valued and enable the investor to avoid the idiosyncratic risk of many consumer-discretionary stocks.
While there are certainly important themes in tech, the challenge remains that the “value” companies have impaired long-term growth trajectories, and the growth companies have stretched valuations, large differences between generally-accepted-accounting-principles (GAAP) and pro-forma earnings, and seem crowded.
You can’t romanticize that you’re a contrarian if you’re bullish on tech and live in Northern California. But maybe, you can dream a bit that you’re a contrarian bull being long financials in New York?
Investors are always asking for signs of a bubble. “New York doesn’t matter anymore” might be a comment to remember, particularly, because it was made by a European who lives in Menlo Park.
As far as the NFL goes—go Pats, and, yes, New York doesn’t matter anymore!
Adapted from a recent edition of Morgan Stanley Research’s “Sunday Start” (Jan 10, 2016) series. Ask your Morgan Stanley representative or Financial Advisor for the latest US equity strategy coverage and reports. Plus, more Ideas.
