by Scott Ronalds

There are a lot of things to love about the U.S. There are also a lot of things not to love. I’m not going to round out the ‘like’ and ‘dislike’ columns here as this isn’t meant to be a cultural or politically-inspired post. What I will say, though, is that “stock valuations” is near the top of our dislike column.

American stocks are expensive. You’ll hear differing views on this, but our managers feel that bargains are hard to come by and in general, U.S. stocks are among the most fully-valued equities in the world right now. Price-to-earnings multiples (a measure of what investors are willing to pay for a company’s stream of profits) are above their historic norms and higher than most other countries.

As well, U.S. companies’ profit margins are at or near peak levels. This sounds great, but profit margins are cyclical, which means they’re due to revert to lower levels at some point. Lower profit margins mean lower profits. And because investors love profits first and foremost, we know how this can turn out.

As Tom often says around here, “High multiples and peak earnings are a bad combination.”

Finally, the U.S. market has had a fantastic run since 2009 and the longstanding bull market is getting long in the tooth. Our research and experience are telling us that we should be cautious of U.S. stocks right now.

In fact, we’re more cautious on stocks in general than we’ve been in a while. Our Founders Fund currently has a stock weighting of 53% (its long-term target is 60%), which is the lowest it’s been over its 6-year history. U.S. stocks make up only 6% of the fund, which is also an all-time low. It always makes sense to own a good proportion of stocks in a balanced portfolio, but we’re playing defence, not offence.

Our three equity funds have varying exposure to U.S. stocks, but the general theme is less America:

  • Our Global Fund has reduced its exposure significantly over the past two years, from about 20% to 8%. Stocks that have been sold for valuation reasons include Alphabet (Google), PerkinElmer, and Whirlpool.
  • Our Small-Cap Fund purchased a few U.S. mid-cap stocks over the last year and a half (Echo Global Logistics, Fluor, Middleby, Stericycle), but they’ve since seen strong gains, and Fluor and Echo Global have been sold. The Fund’s U.S. exposure has decreased from a high of 18% last year to 9% today.
  • Our Equity Fund has the greatest exposure, with 23% of its investments in U.S. stocks, but here too, the manager has been more focused on trimming strong-performing holdings.

This lower-than-normal exposure to U.S. stocks – and equities in general in the case of our Founders Fund – is a big differentiating feature of our funds right now (most balanced and global funds/ETFs have a heavy weighting in U.S. stocks).

Our positioning is purely valuation based; we have nothing against U.S. stocks. Truth be told, we would love to own more at the right price (and surely will at some point in the future). But the price isn’t right. If American stocks continue to rise and outpace all their global peers, we’ll be leaving some money on the table. Indeed, our modest exposure to the U.S. has held back our returns in recent years. But we feel downside protection is a more prudent strategy at this point in the market cycle.