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US buy-back programs obfuscating performance

The United States equity markets’ outstanding performance over the past five years was largely an artificial phenomenon created by mammoth share buy-back programs, according to Tempo Asset Management.

Investors might consider an equal-weighting strategy to mitigate some of the risks created by the inflated stock prices, the boutique investment manager said recently.

“Whether you invest in equities or bonds, you as investors are heavily influenced by the US; much more than people generally think,” Tempo Asset Management principal Joe Bracken said at the recent PortfolioConstruction Forum Market Summit in Sydney.

“The MSCI World is dominated by the US. About 60 per cent of the index is the US, so with every dollar you give to a benchmark-aware manager, you give 60 cents to the US.

“Now, over the last five years that was not a bad idea. The US has given you 16 per cent per year in the last five years, while the rest of the world has done on average 6 per cent.”

This good performance has not had its equal in the history of the US stock market.

“The performance of equity markets in the last five years has not been about the world coming out of the GFC (global financial crisis), not at all. It is that the US has done extraordinarily well,” Bracken said.

“I say extraordinarily because the US is in all respects a very ordinary stock market.”

But he said he believed that was about to change, because at least to some extent US stock prices had been lifted artificially.

“Quantitative easing (QE) gave you what you wanted, but not really what you needed,” he said.

In part, the cheap money that was available to companies during the various QE programs was used to buy back shares, rather than to invest for future growth, he said.

“US management, uniquely, gets rewarded for how well their stock price does,” he said.

“One of the easiest ways to boost a share price is buy-backs. This is exactly what has happened and it has artificially boosted the S&P 500.

“Now, this will become problematic when QE goes away.”

The problem is that drivers for future growth are still largely absent.

“Wage growth has been anaemic, while the US dollar has been weak. This all means that the US has become massively expensive,” Bracken said.

Although there are many ways to apply a bearish view on the US, one of the simplest and cheapest ways to do it is equal weighting.

Bracken showed that by creating an equally-weighted portfolio using only index trackers, investors could generate a consistent outperformance compared to a global index.

“Equal weighting gives you about 1 to 1.5 per cent a year over the MSCI World Index,” he said.

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