In the last 30 years you’ve had a wonderful ride if you’ve invested as much of your capital as possible in the US equity market: Anton Eser – CIO, 10X Investments.

SIMON BROWN: I’m chatting with Anton Eser, chief investment officer at 10X Investments. Anton, I appreciate the time today. In a note that you put out – which probably needs more time than we have, and certainly is a brave one – you’re saying it’s time to rethink how we weight US stocks in our global equity portfolios. Certainly over the last couple of years, truthfully a decade,  it has been a wonderful place to invest. A lot of it of course [in the] magnificent seven, but the returns have been great over the last five, 10, even maybe 12 years.

ANTON ESER: Yes. Hi, Simon. Actually longer than that. You can almost go back to the late eighties when Alan Greenspan took over the Federal Reserve. In the last 30 years real returns in US equities have been close to 8%, and in the last 10 years over 9%. But it’s been a wonderful ride if you’ve invested as much of your capital as possible in the US equity market.

SIMON BROWN: Part of the challenge – and I want to drill into some of the issues – is you made a point in the article that you put out around tax cuts, for example. They’ve undoubtedly been a driver both of equity and to a degree of growth. Of course at some point you run out of road for cutting taxes.

ANTON ESER: Yes, it kind of began, if you remember, back in the eighties with Reagan. Tax rates then in the US were in the mid-forties, and there has just been a kind of steady decline. Every single particular Republican president that’s got in has cut taxes, and the Democrats haven’t increased them. So your average tax rate has gone from kind of the mid-forties to an effective tax rate closer to 15% now in the US. And that has contributed something like 0.8% to net income growth in the US over that period. So it’s been a big tailwind.

SIMON BROWN: And that tailwind has helped. If we then dig into the data, you make the point that you’re not expecting earnings growth of giant numbers going forward. The US has grown, but it’s almost sort of muddling along. And if we look at the multiples, they need better growth for the multiples that we see.

ANTON ESER: Yes, I mean that’s exactly right. Just take a little step back and look at that earnings growth. In the last 30-plus years you’ve had economic growth in the US of 2.5%. And obviously it has been a phenomenal time, and we’ve had leading US companies, we’ve had the internet, we’ve had globalisation [and] now artificial intelligence. But it’s fascinating. If you look at sales, top line sales growth of non-financial corporates in the US within that S&P 500 are under 2%, so 1.9% real sales growth.

So through that incredible time actually US corporates have kind of grown below GDP in the US. But an additional point really is that what has added to that EPS growth has been this point around tax cuts. So a 0.8% contribution.

And then the second one is, as we know, this continual period of reduction in interest costs. Interest costs have contributed 0.7%. So, if you add all of that up, almost 40% of earnings growth – so EPS growth in the US since the late eighties has come from interest cost and taxes.

And then you make the final point there, which is around valuations. So valuations, the multiple back then was 15, it’s now over 30. And valuations are very sensitive to interest rates. They are discounted at future interest rates. So a large portion of that, multiple expansions also come from interest-rate decreases over that period of time. It has really been the main driver of that 7.9% US equity return in real terms we’ve seen in the last 30 years.

But, as you say, that really in the last couple of years has come to an end. So it does really change the outlook from here in terms of what we can expect from long-term returns in the US.

SIMON BROWN: And that’s the key point. We are not talking about a crash in the next days or weeks; we are talking around the next decade or so. And reversion to the mean, the lower growth coming through, certainly suggests that we’re not going to get the sort of returns that we’ve had from equity in the last couple of decades.

ANTON ESER: Yes, that’s right. Who knows really what happens in the next six months – the next 12 months, even. It’s very hard to forecast. Long-term returns can very much be driven by  something much more around the numbers. So just go back to them. If you look at the 10-year GDP forecast, the CBO actually, so it’s the US government which is typically overly ambitious, it’s 2%.

Now, if you kind of just run the numbers and we refinance at these levels, and let’s just assume that tax rates stay incredibly low, the Trump tax cuts next year get rolled over and all these things, so we stay at that very low 15% rate, then we have an earnings growth of 1.8% in the US, and that’s actually making some pretty bold assumptions – therefore earnings are in line with GDP, whereas in the last 60 years they have been below GDP – and you take that 1.8% and you feed it into a model, and you take your valuation multiple, that number 30 that I mentioned earlier, you kind of have some form of a mean reversion.

And if once again we take the optimistic side, we take a mean reversion to a much more recent … multiple of 26, we start to get to kind of real returns of just over 1%. And if you go to longer-term valuations, then you actually get a negative real return expectation in US equities of 0.6%.

So that’s a big change in the world we’ve been living in in the last 30 years, plus 8%, 9% real returns in the largest market in the world, really in the next 10 years going somewhere closer to zero to 1%, it just changes the dynamic completely of how you manage retirement portfolios.

SIMON BROWN: So where does that leave the investor looking for good old-fashioned quality dividend payers, valuations – and of course bonds which are enjoying their day in the sun at the moment.

ANTON ESER: Yes. I think there are two or three takeaways here. I think firstly, absolutely, that first point is that for the first time in a long time real return expectations and bonds – be it developed market and definitely the South Africa market – are attractive.

Secondly, outside the US emerging markets are much more attractive than using the same maths that we’ve gone through here.

And then the third point, which is the crucial one, as you say, this  is very distorted by big tech in the US. If you take a much more equally weighted, let’s say, S&P 500, the numbers are a lot more attractive – and a lot of that is very much skewed towards defensive plays – the names that we all know, which are trading at much more attractive valuations with actually pretty good earnings growth over the last 10 years.

So those are really the three actions to take away. If one thinks long term, short term, it’s a completely different story.

SIMON BROWN: We’ll leave it there. Anton Eser, chief investment officer at 10X Investments, I appreciate the time.


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