Our thoughts on equity asset allocation and results from AmEx

Market News

US equity recovered slightly as investors dialled back hedges put on before the weekend against an escalation of the Middle-East conflict. This morning in Asia, markets sold off, with China dragging the region lower after Beijing launched a probe against Foxconn: Nikkei 225 (-0.8%); Hang Seng (-0.7%); Shanghai Composite (-1.9%). The FTSE 100 is currently trading 0.3% lower at 7,374.  Safe have assets drifted lower: the 10-year Treasury currently yields 4.98%, while gold is $1,976 an ounce. Sterling trades at $1.2160 and €1.1492.

In Europe, some of the biggest money managers think it’s wrong to bet the ECB is done hiking. Markets underestimate the odds of tightening in response to rising energy prices if the Middle East war escalates, Legal & General, Vanguard, and Robeco said. Meanwhile, ECB officials weighing whether they’ve raised borrowing costs far enough are dealing with a related challenge: how to ensure their policy continues to work.

However, Bloomberg Economics says global inflation is expected to moderate and decelerate to 6.4% year on year in the final three months of the year, and down to 4.6% in the fourth quarter of 2024. It also said markets may be under-pricing the probability of a rate increase this year with almost even odds between a hike and hold.

Americans are falling behind on their car loans at the highest rate on record. The percentage of subprime auto borrowers at least 60 days past due rose to 6.11% in September, the most in data going back to 1994, according to Fitch.

Brent Crude slipped to $90.50 a barrel. Europe is considering whether to extend an emergency gas price cap amid fears that the Middle East conflict and pipeline sabotage may elevate prices this winter, the FT reported. There’s “no indication of negative effects” since the cap began.

Source: Bloomberg

Asset Allocation – Nothing Lasts Forever

Those who follow equity markets closely will be under no illusions about where the place to be has been in recent years.  The US equity market has handily trounced all-comers.  For US domestic investors who often have little overseas exposure, this has been great news.  However, it has also been good for non-US investors who adopt a global approach to investing.  The US makes up a huge part of the investing universe for global mandates and hence non-US investors have benefitted significantly.

S&P 500 (blue) versus MSCI Emerging Markets (orange) Indexed to 100 (Oct 2017 to date)

Source: Bloomberg

Nowhere has this outperformance been more obvious than versus emerging markets.  The chart above shows the huge gap that has opened up in recent years.  However, this has not always been the case.

S&P 500 (blue) versus MSCI Emerging Markets (orange) Indexed to 100 (Oct 2001 to 2007)

Source: Bloomberg

In the early part of this century, it was a very different story.  The chart above presents the same data series but between 2001 and 2007.  This time it was the emerging markets that did the trouncing and by an even wider margin than the current inverse disparity.

S&P 500 Relative to MSCI EMs (black, normalised to 100) versus the Dollar Index (magenta) 1990-date.

Source: Bloomberg

The final chart takes an even longer perspective and demonstrates the relative performance of the S&P 500 versus the MSCI Emerging Markets Index (black). The black line rising shows the S&P500 outperforming and vice versa.  Overlayed is the Dollar Index (magenta) where a rising line shows dollar strength.  The relationship is clear.

The point of this short piece is not to analyse why we have had these long periods of outperformance or why certain relationships hold.  The point is that to most investors today, international diversification means a significant bet on the US.  This has been a good bet in recent years, but it doesn’t tell us anything about whether it will be a good bet in the future.  True diversification means a meaningful allocation to both areas rather than allowing recency bias to drive allocation decisions.

Company News

Last Friday, American Express released Q3 results that were better than expected at the profit level. However, the company raised its provision from credit losses, and in response its shares fell by 5% in US trading hours. Industry peer Visa was unchanged.

AmEx is a globally integrated payments company whose platform includes card-issuing, merchant-acquiring, and card network businesses. American Express cards issued by American Express as well as by third-party banks and other institutions on the American Express network are accepted at millions of merchants around the world. The group has c.130m cards in force generating around $1.4tn of annual billed business worldwide. From 2024, the group has an aspiration to grow revenue by more than 10% per annum and EPS in the mid-teens.

The company is benefiting from the ongoing shift from cash and cheques (which still amounts to $17 trillion, growing at 2% p.a.) to electronic means of payment, and the growth of online retail and mobile payment systems. We believe the industry is at an inflection point in terms of sales growth driven by the global proliferation of smart devices which provide a way to pay and to be paid. The group will also benefit from growth in connected devices and commercial payments. In emerging markets, a lack of physical communication infrastructure traditionally provided a barrier to payments growth, but that has been removed by the emergence of mobile phone technology and a government focus on digitalising cash to reduce the black economy. Many of these trends accelerated during the pandemic.

In the three months to 30 September, consolidated total revenue net of interest expense was up 13% at constant currency to a record $15.38bn, in line with market expectations. Growth primarily reflected continued growth in card member spending and best-in-class credit performance. The results were also helped by resilient spending from the group’s wealthy customers who shrugged off concerns about an economic downturn.

Revenue was made up of discount revenue (55% of the total, growing by 7%); net card fees (+20%); service fees and other revenue (-8%); processed revenue (+1%), and net interest income (+34%). The group saw continued high levels of customer engagement, acquisitions, and loyalty across its premium card member base. Total network volumes grew 7% to $420.2bn, made up of billed business (+7%) and processed volumes (-1%). Card member spending grew by 7%, with the US up 9% and International Card Member spending up 15%. Travel and Entertainment spending remained strong across customer categories and geographies, growing 13%.

In a sign of caution, AmEx boosted its provisions for credit losses by 58% to $1.23bn to account for the increased likelihood of consumers defaulting on their debt. The increase reflected higher net write-offs partially offset by a lower net reserve build of $321m, compared with a reserve build of $387m a year ago.

Consolidated expenses were up 7% to $11.0bn, primarily reflecting higher customer engagement costs, which were driven by higher network volumes and increased usage of travel-related benefits, partly offset by lower marketing expenses. Net income per share was up 34% to $3.30, versus the market forecast of $2.94, helped by a lower tax rate. The quarterly dividend was increased by 15% to 60c.

Based on performance to date, the group continues to expect its full-year revenue growth to be 15%-17% and EPS in the range of $11.00-$11.40. Management also believes the company is well positioned as it seeks to achieve its long-term growth plan aspirations in 2024 and beyond in a steady-state macro environment.

Source: Bloomberg