The US equity market is the elephant in the room for any institutional investor. It has also been a very excitable elephant with the S&P500 reaching all-time highs in the first half of 2015. Even the banking sector, perhaps the one most affected by the global financial crisis, has its admirers, particularly for some of the regional banks with strong and cheap retail funding which would benefit immensely from an increase in spreads arising from the Fed raising rates. 

But the US economy, despite a great deal of hype in the press, has not shown much real sign of a strong recovery. That leaves institutional investors in a precarious position. While everyone accepts that valuations are controversial, most also acknowledge that the US markets certainly do not look cheap, and on some metrics, such as replacement value and CAPE, may be as much as 80% over-valued. Should investors pull out of US equities now? Few would dare do so. But valuations are only part of the story and, in any case, are only weak predictors of market movements, at least in the short term.

The more controversial issue may be how robust future growth is likely to be for the US economy. The US still represents perhaps the most dynamic economy in the world, and the list of major global companies that have arisen just in California alone over the past decade or so is truly amazing. 

But, yet, there is still a nagging doubt that the rise of the S&P500 might not truly represent the fundamentals for the US economy, with a number of drags on economic growth including demographics, slow productivity growth and elevated debt levels. 

One clear fact is that among the major buyers of US equities have been US corporates themselves buying back shares and this is a major cause for concern. Managements have contracts that pay them on the basis of measures such as short-term improvements in share prices, which incentivise them to undertake buybacks even when shares are expensive. This may be in their interests but not in the interests of shareholders. This, combined with pay packages that seem to reward management at levels far beyond what has been the norm in the past, has also arguably contributed towards the US itself becoming a more divided society.    

If the US is not seeing a recovery now, when can it expect to do so? There are plenty of arguments on the role that fracking might play in capping oil prices, stimulating domestic manufacturing, but it is the US consumer who drives the economy, and consumer spending will only increase once confidence comes back as a result of the housing market swinging back upwards. That may still take another year or two.

Time to focus