Questor: How to avoid a potential US markets crash

Why the UK stock market is proving less volatile than America’s

The much-maligned UK stock market is having a less turbulent summer than that of America, which ultimately may be due simply to valuation and relative levels of expectation.
In brief, the US market has done so much better than its UK counterpart in recent years, meaning its valuation is higher – and so are expectations. 
Over the last five years, the S&P 500 has risen by 82pc, while the FTSE 100 has eked out a 12pc advance over the same time period. As a result, this may leave it more exposed on the downside in the event of any unexpected shocks.
The UK benchmark trades on a lower valuation multiple, at just 12.5 times forward earnings for 2024 and 11.5 times for 2025, compared to the S&P 500’s 23.3 times and 19.9 times, based on consensus analyst forecasts and S&P Global Research.
Meanwhile, analysts are looking for a second straight drop in aggregate earnings from the FTSE 100 in 2024, with a modest 8pc rebound in 2025 (to leave next year’s predicted net income figure at £183bn, a fraction below 2023’s out-turn of £185bn). Some investors may see that as reasonable given the uncertain global economic outlook.
In the US, however, S&P Global research suggests US analysts are looking for 11pc earnings growth in 2024 and 17pc in 2025 – and that is on top of 8pc growth in 2023.
There are good reasons why the trajectories could be so different – America may still be basking in the fiscal stimulus provided by the Biden administration’s Chips and Inflation Reduction Acts, benefiting from increased onshoring and also the S&P 500’s much greater exposure to areas such as technology, where hopes for an AI-inspired spending and productivity boom continue to run high.
But this also increases the risk of downside in US equities should any unexpected disappointment creep up and sandbag those earnings forecasts – either because the economy slows down; AI fails to deliver a satisfactory return on the initial huge outlay made by corporations who then pause spending here, or even retrench; or there is an exogenous shock.
Just look at the sharp falls in US equities – and the Magnificent Seven in particular – in 2022 when corporate earnings stumbled, just as interest rates began to rise and supply chains unwind after the damage caused by Covid-19 and lockdowns. 
The UK may be more sheltered from these risks owing to its lesser price tag and lower valuation. Although it would be wrong to say it is entirely immune to such threats, especially as the USA is the world’s largest economy and an important trading partner, the FTSE 100’s less volatile showing suggests it could offer some protection in the event of a wider market dislocation, partly as valuations and hopes are lower, and partly because it has a greater exposure to stodgier – or less cyclical – areas such as consumer staples, telecoms, utilities and health care.
This may all be academic if markets regain their footing. A rally is by no means out of the question as investors do seem to have rather lost their marbles – a surge in the Vix, or fear index, to an intra-day high of 65 last week suggested that markets at one stage feared an outcome as bad as that seen in 2008 during the Global Financial Crisis, or 2020 during the pandemic.
In this respect, the Vix could be a handy contra-cyclical indicator, at least in the near term. 
The long-term average reading for the so-called ‘fear index,’ which is used as a measure of anticipated volatility in the US stock market, is 19. 
A long spell of readings at 12 or below can be suggestive of very bullish sentiment, even complacency, so it may not take much to frighten markets into action. Equally, a rash of readings above 30, or spikes higher still, could be suggestive of panic and therefore that markets may be oversold as investors blindly dump stocks.
In this respect, volatility can be the investors’ friend, as it presents them with a chance to buy assets cheaply (when others panic) or sell expensively (when others get carried away). The skill is to build a portfolio with sufficient downside protection and robust characteristics that it can see the investor through to the other side of any squalls, without them becoming a forced seller due to too much risk.
All this does is distil Warren Buffett’s maxim that investors – if they are brave enough to try and time the markets – should be fearful when others are greedy and greedy when others are fearful. 
Ultimately, valuation and the price paid dictate long-term investment returns, not fancy narratives, whether they are AI-related or not.
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