Is there too much optimism in US equity markets?
4 July special
Ahead of the US celebrating its 4 July national day, Investment Week looks at the outlook for US equities and whether the market’s outperformance since its March lows is justified or if investors have become overly optimistic.
The S&P 500 index is up 3% year to date, having recovered from a decline of more than 20% in mid-March as the coronavirus pandemic wreaked havoc on global equity markets, while the MSCI World index is up 1.3% according to data from FE fundinfo.
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US growth and tech stocks have been some of the beneficiaries of the economic conditions of lockdown, with the Nasdaq returning 26.5% year to date, up 54.5% since 16 March.
US equity portfolio specialist at T. Rowe Price Eric Papesh noted that despite "a lot of optimism currently being priced in" the real economy has "declined meaningfully".
He said that in the coming months and quarters investors should expect "a higher level of volatility than we have generally been used to over recent years" in US equity markets, noting the country's "progress, or lack thereof, in fighting the pandemic" with the infection rate skyrocketing in many states.
Multi-asset CIO at Neuberger Berman Erik Knutzen warned that investors should not become overly optimistic in response to recent better-than-expected jobs data, which saw the US create 2.5 million jobs, while retail sales have jumped a record 18% and PMI is picking up.
Knutzen said: "While some of these headline growth numbers have been remarkable, it is important not to be misled by low-base effects or to confuse a strong recovery with a full one.
"Two and a half million jobs in the US is great news, but we need almost ten times that to get back to the unemployment levels of four months ago. PMIs have rebounded, but most indicate activity is still contracting, not expanding."
He added that "once equilibrium is established" investors should expect conditions of "low growth, low interest rates, low productivity and high debt", compounded by "even higher debt, even lower rates, higher taxes, tighter regulation, lower consumer confidence, ongoing social distancing and travel restrictions, and, potentially, a steep cliff edge on the other side of the current fiscal stimulus".
Head of US equities at Artemis Cormac Weldon said there is "notable scope for further disappointment" in US equity markets with recent economic data dampening "optimistic pricing" trends.
He added: "Notwithstanding the positive data on US employment recently, we feel that current expectations for unemployment at the end of 2020 are too optimistic.
"It is difficult to see the unemployment rate returning quickly to the single digits as the effects of the pandemic unfold.Market prices currently reflect investors' willingness to take a positive view of economic data, as well as confidence that the Federal Reserve and Congress can and will do more to support the economy if it falters. We are back to the market levels we had at the beginning of the year. We regard this with a degree of caution.
"The negative impacts of the crisis (e.g. more home-based activity) has resulted in high valuations for some stocks, and some of this will be merited. But, particularly as the rally widens and assumptions factor in a return to ‘normal', it remains to be seen how quickly we can go back to pre-crisis levels for many companies and sectors."
Global equities portfolio manager at Sarasin & Partners Giles Money said investors should not expect the dominance of the largest US "ultra-cap" firms like Apple, Amazon and Microsoft to slow down despite "the advent of new regulation and taxation systems for these companies".
He explained that this will not "stop the deployment of capital and subsequent growth for these businesses", and that Sarasin is "still finding valuations we are comfortable with, due to the positive backdrop relative to other much more challenged industries going forward".
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Money added: "Where economic growth rates are low, the share of thematic and structural growth rises. This leaves us with an increasingly thematically driven world. Digitalisation, which is one of our five key themes at Sarasin & Partners, has likely accelerated as a result of Covid-19 - with e-commerce up close to 70% year-on-year in the US.
"The question from here will be around which behaviours last, but what is clear is the US has many structural advantages."
However, head of global equities at Mirabaud Asset Management Anu Narula said investors should expect an inversion of the trend of cyclical stocks lagging, with the sector set to lead market gains going forward.
He cited PayPal and computer games company Nvidia examples of stocks benefiting from secular trends which will continue in the long term, and "while these companies look expensive on headline measures, the market often underestimates the ‘E' of P/E".
With regard to the "recovery bucket", Narula added: "Consumer cyclicals can fulfil the same function in a portfolio which energy or industrials did in previous cycles. Over the long term, they are also better quality franchises. Such examples include TJX, Starbucks and Home Depot.
"There will be a rotation between these buckets as we move out of the recession, and we want to ensure a balance between both."
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