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Why U.S. markets are underperforming Europe, parts of Asia

Director of Strategy and Content at Edison Group Neil Shah joins Yahoo Finance Live to look at the U.S. stock market and growth stock trends amid international trends.

Video transcript

- We're taking a look at US markets, optimistic on high hopes the President Biden and House Speaker Kevin McCarthy's debt ceiling deal will get through a divided Congress before the dreaded X deadline. But despite the tentative deal, investors remain uncertain about the overall health of the economy.

For more on the markets, we're joined by Neil Shah, Director of Strategy and Content at Edison Group. Thank you for joining me this morning. So at first, I really want to get your gauge of what markets are really trying to digest at the moment, and how much of this optimism is perhaps overly priced in.

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NEIL SHAH: I think there's still a fairly healthy degree of caution in the markets, particularly around the US market, concerns, no one's really confident around the outcome. So does the US avoid a recession, or do we see a hard landing. That is going to be drawn out over the second half of this year. And I think there's a reticence to deploy capital while that is out there.

So I'm seeing quite a lot of caution from investors about moving into new names. I think growth is a premium right now, and I think that is being reflected in some of the large cap tech names doing well. I think liquidity is important. You've got to be able to get in and out of stocks. So again, the large cap names doing reasonably well.

But it's notable that the US indices have underperformed the European indices. And I think the US is in a very different place to Europe right now. The concerns around growth are growing.

- And you mentioned the comparisons with Europe, and the US markets underperforming versus Europe. And some parts of Asia as well. Talk about the dynamics in play. Perhaps, how people can see opportunities in this.

NEIL SHAH: Yeah. I mean, I think that Europe surprised the upside. I mean, a lot of markets are around expectations. So if you set yourself some low expectations, you can see some upward surprise to that. There were genuine concerns about Europe's dependence on fuel prices from Russia, et cetera, and I think those have eased.

As energy prices are coming down, I think the European economy, and the outlook for the European economy is slightly more robust. We seem to be in a very different place to the US where I think the rate rising cycle is probably coming to an end. There's more concern about whether you actually move into a deflationary cycle in the US, whereas in Europe there's still scope for a little bit more tightening.

The growth numbers are coming through, and it's telling us that investors are looking for growth over and above the cost of capital here. European companies have done reasonably well in terms of the last reporting cycle, and they're at more attractive valuations than the US peers, and that's drawing investor interest in the region.

So if you look at the year to date numbers, S&P up a couple of percent, Europe is up nearly 12%, and that's drawing some attention. You're seeing a similar picture in some of the Asian markets. It's mixed but Japan's done really well. I think this is, I was listening to your previous guests in terms of caution around China, but there is expectation that Japan will be a beneficiary as China reopens as the Chinese consumer strengthens.

And again, the valuations of a lot of those Japanese companies are relatively cheap so it's attracting investor interest. So I think the hedge is you're moving into value names to protect yourself from downside risk, you're looking for growth, and Europe and pockets of Asia are drawing investor interest.

- So then as we look at China, we look at the CSI 300, which is essentially an indicator of China's stock market performance, similarly to how we view the S&P 500. It did enter a bear market, though. Do you expect, perhaps, the S&P to follow suit. Or what will perhaps be the difference of what will make or break whether or not the S&P follows that suit.

NEIL SHAH: Well look, I mean, I think if I look at valuations for the broader US market, you're looking at PE multiples of around 15 to 18 times forward looking earnings. And if you're moving into a zero growth environment, I would expect those numbers to attract people back into the market, you probably need to be at 12 times.

And so there is to me there's a sense of those valuations need to adjust downwards. Now, the one thing we know about the US market it's a pretty dynamic place. And there's a lot of people who believe that actually we're not going to see a recession in the US and that it will work itself through the next six months and actually growth will surprise to the upside.

The problem is that we just don't know right now. So there is caution. I think the market's looking for evidence one way or the other, and to get conviction that we're heading in one direction. And if I was managing money today, I would be holding fire because I think there are some very, great stocks out there. My sense is that you might be able to pick them up a little bit cheaper later on in the year because I'm anticipating some market volatility as this debate takes place.

- So Neil, are we talking more interest in commodities, or what aspects would you be looking at as you're looking at some of your picks.

NEIL SHAH: So typically, I mean, the sectors I think that are going to continue attracting interest, I think, you've seen them already. The large cap tech names are doing well. I think, over time, particularly as the rate cycle starts to flatten out, those names that can grow, which will be in those growth sectors, will start to attract interest again.

The other areas that I think are starting to gain a lot of interest are the cyclical. So inevitably as you move into a recessionary environment and these stocks get beaten up, they're the first things that give you outperformance of the cyclical names. Because inevitably you'll come out of that cycle.

So there's a lot of work being done in terms of which are the high quality industrial names, which are the high quality cyclical names. I don't think people are deploying caps to them right now, but I think they're getting ready to put them in, but put money to work later on in the year.

My sense right now is that it's, to a certain extent it's where we were six months ago. That if you're building a long-term portfolio for four or five years worth of outperformance, the stocks that you need to ride out the near-term cycle is going to be very different to the stocks that you want to have in that portfolio over a longer term trajectory.

And hence I think it's actually quite hard work, allocating money to names. Which is why we're in the market we're in right now, which is, it seems a little bit directionless, it's waiting for something to catalyze that change. And I think we'll see that play out over the next three months.

- We'll certainly be keeping track of that. Neil Shah from Edison Group. Thank you so much for joining me this morning.

NEIL SHAH: Pleasure