Difficult to make strong case for US equities

Difficult to make strong case for US equities

The US economy is showing real signs of recovery. The US Federal Reserve has finally ended its massive quantitative easing programme, growth is looking reasonably healthy, unemployment is falling and the housing market is clambering out of the trough.

It is not surprising, therefore, that our forecasters are all relatively positive on the economic outlook for what is still the world's biggest economy.

But the US stock market has also been powering ahead, partly anticipating the return to growth that is now being seen, but also reflecting the liquidity-driven boom pushing up the price of all types of assets across the globe.

tempered enthusiasm

Over the last five years, the S&P 500 has risen more than 75 per cent, three times faster than our own and Europe's leading markets, and valuations are nearing the top of their range. For some, therefore, economic enthusiasm is tempered by concerns over valuations.

Paul Niven, manager of the Foreign & Colonial investment trust, sums it up: 'On conventional measures, both long- and short-term, [the US market] is trading at the rich end of valuations. You can argue about how far away it is from fair value, but it is difficult to make a strong case for US equities.'

US companies have been doing well, with margins and profits both looking healthy. But, as Niven says, that is a double-edged sword.

'If margins and profits are already elevated, it is less clear that there is much scope for improvement beyond these levels. Progress will, therefore, depend on top-line growth generation - how much more they can sell and how much more they can squeeze out of costs.'

Andrew Bell, manager of Witan Investment Trust, says that the US has 'finally got to the point where it is self-sustaining', with consumer confidence improving.

Interest rates are set to start rising next year, 'although the pace of increases will be much more modest than in previous cycles'. But he believes that much of that optimism is already priced into the stock market, so it will be harder to make money from US equities.

Angel Agudo, manager of Fidelity American Special Situations fund, is also relatively cautious due to high profit margins and company valuations. However, he says: 'I am encouraged by the continued strength in the US economy and by the fact that inflationary forces exist, but are contained enough to allow the Federal Reserve significant flexibility in policy.

leadership

'The US has clearly taken back its leadership position in the global economy and investors are refocusing their attention on the unique structural advantages it enjoys.

'These stem from its access to relatively cheap energy and labour, and an institutional structure that supports entrepreneurship, innovation and a profit focus, and is flexible enough to withstand periods of crisis.'

He says he is finding 'some pockets of value in the energy sector and amongst retailers', with the latter expected to benefit from lower oil prices and the early signs of wage inflation. 'I also continue to find interesting investment opportunities in the medical technology space,' he adds.

Some managers are more enthusiastic, however. Simon Laing, head of US equities at Invesco Perpetual, thinks both earnings outlook and market valuations are positive. 'We see a decent year ahead for US equities. Earnings growth for 2015 should come in around 4-5 per cent.

'There will certainly be an earnings drag in the energy sector due to lower commodity prices, but there will also be an offset from stronger consumer-facing industries that benefit from lower oil and gasoline prices.'

He also believes that valuations could actually go higher than the 16 times earnings on which the market currently trades, adding: 'We see no reason not to expect another year of decent 6-7 per cent equity returns.'

But Tom Walker, manager of the Martin Currie Global Portfolio trust, goes against the consensus with a prediction that interest rates will not rise in 2015. 'The economy is simply too fragile, and the Fed has invested five years and billions of dollars to avoid the dip back into recession that we now see in Japan and may yet see in Europe.'

The strengthening US dollar, Walker points out, could negatively impact on the exports and margins of exporting companies. 'So, yes, the US is attractive in relative terms, but in absolute terms the news remains mixed.

'Market valuations are quite stretched, though not necessarily overstretched given the low interest rates. With the ongoing support of the US Federal Reserve, the S&P 500 can grind higher.'

Passive routes into the US

As well as some of our favoured actively managed funds and trusts, which we outline in our Rated Funds sections, you can find a few cheaper passive versions below.

Vanguard S&P 500 ETF tracks the main US index and has an ongoing charges figure (OCF) of just 0.07 per cent. It has returned 16.7 per cent over the year to 21 November, marginally ahead of the benchmark.

The SPDR S&P US Dividend Aristocrats ETF tracks the dividend aristocrats index of companies with at least 20 years of consecutive dividend increases. Its OCF is 0.35 per cent and it has returned 17.4 per cent over a year.

The iShares S&P 600 Small Cap ETF tracks US smaller companies. It has an OCF of 0.4 per cent and has returned 8.6 per cent over the year.


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