What is the outlook for US equities?
With the bull market in US stocks in its stride, how should advisers' clients be positioned in the asset class?
Advisers with clients invested in US stocks will have been reaping the rewards of the bull market since 2009.
But many worry that a combination of macroeconomic factors and rising political tensions may prompt the US equity market to decline.
Is it the end of the bull run, or do stocks have further to go? And should investors ignore the noise and maintain their exposure to the US market as part of a diversified investment portfolio?
Read on to find out whether clients should be adjusting their exposure to US equities.
Advisers weigh up risks to rising US stocks
Some 47 per cent of advisers think nothing will derail the current bull market in US equities and it will continue, according to the latest FTAdviser Talking Point poll.
The poll, which asked advisers what clients invested in US equities thought will derail the bull market, revealed that 24 per cent of clients believed potential trade wars, including political risk, would conclude its run.
Anthony Rayner, manager of Miton’s multi-asset fund range, said trade wars and political issues did indeed pose a risk to the US stock market’s derailment.
The US equity market will go up and it will go down, any short-term fluctuations will not have a significant impact in the grand scheme of things.
"Politics is a different ball game. Markets have always struggled to price political risk and we do too," he said.
He noted: "There’s a fairly full pipeline of events coming up, including US midterms, Italian budget proposals, Brexit negotiations and a Brazilian election."
The bull market in US stocks has lasted for more than nine years and five months, now making it the longest running bull in history, according to Schroders.
A bull market is defined as an extensive period of a rising market, which does not fall more than 20 per cent from its peak during the period, and often leads to speculation as to when it will end and what will end it, the asset manager explained.
The poll results showed 19 per cent of advisers thought central bank action could conclude the record-breaking bull run, while a mere 10 per cent said tension in emerging markets could play a part in the end of the bull market.
But Joshua Gerstler, financial adviser and company director of The Orchard Practice, believes the short-term outlook for US equities is unlikely to affect clients’ investment allocation.
He said: "I work with my clients in planning for the [long term] so I encourage them to ignore the market noise."
Mr Gerstler added: "The US equity market will go up and it will go down, so any short-term fluctuations will not have a significant impact in the grand scheme of things."
Arun Mohammed is an intern with Financial Adviser and FTAdviser
CPD: Should US equities form part of a diversified client portfolio?
Words: Ellie Duncan
Investors will have done well out of holding US equities over the past decade.
However, US equity investors may now want to consider how they are positioned in the region, as short-term risks heighten.
The 15 September 2018 was the 10-year anniversary of what has become known as the Great Financial Crisis.
It was the day 10 years ago when Lehman Brothers – which had been one of the largest US investment banks – collapsed.
The anniversary, earlier this month, was a reminder of the huge impact of the recession, which went on to rattle investors in the UK and throughout the rest of the world.
But for the past nine years, US equities have been in a bull market – a rising market which never falls more than 20 per cent from its peak, according to a definition from Schroders.
The bull market in US shares has certainly helped boost sales of US equity funds.
Figures from the Investment Association show UK investors have been piling into US equity funds for much of this year, as stocks continue to climb, only pulling out of this asset class more recently.
Net retail sales of the IA North America sector peaked at £446m in April 2018, although investors continued to plough money into funds in this sector in June, when net retail sales were £248m.
However, escalating tensions between the US and China over trade tariffs, as well as various other macroeconomic concerns, have worried investors.
Investors are understandably concerned that the clock is counting down and that the next recession is potentially just around the corner.
US equity funds registered outflows of £293m in July, the Investment Association figures show, having averaged net retail sales of £145m for the previous 12 months.
Certainly, political unease appears to have struck a nerve with UK clients exposed to US companies.
The length and strength of the bull run may also be causing investors to get out of the asset class ‘at the top’, with many believing it is only a matter of time before another downturn in US markets, or even another recession.
Julian Cook, a US equities portfolio specialist at T Rowe Price, observes: “Investors are understandably concerned that the clock is counting down and that the next recession is potentially just around the corner.
“However, the robustness of US data, both economic and corporate, suggests that we are still some way from the end of the cycle. This is usually associated with rising inflation, aggressive monetary policy, and deteriorating company profit margins.
“So far, we have seen limited signs of these things in the US.”
He reassures investors: “At the corporate level, despite trade-related concerns, US companies continue to deliver outstanding results, with a high proportion meeting or exceeding earnings expectations.
“From a valuation perspective, the US equity market is currently trading at above-average levels. However, given the strong earnings results that we are seeing, the current price to earnings multiples do not look especially stretched in our view.”
But other managers are more concerned about the risks of being exposed to American companies.
Simon Evan-Cook, a multi-asset fund manager at Premier, recently told FTAdviser he is not investing in US shares, saying that with valuations at current levels it will be difficult for investors in most US stocks to make a profit in the year ahead.
So should advisers’ clients have any exposure to US equities at all, given the strong run they have had?
Richard Stammers, chief investment strategist at KW Wealth, says they absolutely should.
“The US equity market is huge and ignoring it would be foolhardy at best,” he reasons.
“Arguably, since the Great Financial Crisis, all you needed to have held was US equities.
“Of course, we know diversification matters and so this is not something we would have done – but we still allocate more than a third of our ex-UK equity money to the US equity market.”
Darren Cooke, a chartered financial planner at Red Circle Financial Planning, agrees: “All clients should hold a globally diversified portfolio – it is almost impossible to imagine doing that without having an exposure to US markets, as it is the single biggest stock market in the world based on market value.”
The political noise coming of the US has, at times, been deafening this year, as President Donald Trump ramps up his trade war with China.
Short-term or long-term horizon?
But does this pose a real risk to US equities and the clients exposed to them, or should investors continue to fix their gaze on the long-term?
Kully Samra, vice-president of Charles Schwab, observes: “Macroeconomic and geopolitical events have no doubt given stock markets some jitters over the past six months, but headlines can often be a distraction from the fundamental investment cases.
“US equities should be considered a key component of any balanced portfolio. The US remains the most established, liquid and capitalised market in the world.”
He points to the strength of the underlying economy, low unemployment, a tight labour market which is leading to accelerating wage growth, and higher-than-expected corporate earnings.
“While political sabre-rattling can spook investors, we believe that economics and markets have had a larger impact on politics than the other way round,” he notes.
Longer term, we are nearer the end of the business cycle than the beginning, so investors would be prudent to consider their time horizons and how much risk they want to take.
Just this month, President Trump announced he would be imposing another set of tariffs on Chinese goods. From 24 September, taxes of 10 per cent on $200bn worth of Chinese imports will be applied.
The war of words between the US President and China’s President Xi Jinping has escalated in recent months.
Witold Bahrke, senior macro strategist at Nordea Asset Management, says: “With the US trade deficit vis-a-vis China reaching new highs in July, there are good reasons for [President] Trump to not back down at this stage – especially ahead of the US mid-term elections.”
He points out: “In total, half of China’s imports to the US are now ‘tariffed’, with [President] Trump threatening to tax all imports from China if Beijing opts for retaliation.
“The trade war is currently living up to its name.”
Mr Bahrke adds: “At the same time, a 14-year high in US manufacturing confidence and the performance supremacy [of] US equities is an impressive demonstration of how immune the US economy and markets currently are to the trade tremors.
“As long as [President] Trump’s popularity among Republican voters stays strong, we do not expect trade headwinds to fade meaningfully.”
While trade wars do pose a risk, there is still the wider question around whether US stocks have further to go, and if not, what that means for advisers’ clients with exposure to the asset class.
For Mr Stammers, the question of whether investors need to alter their allocation in preparation for a decline in the value of US stocks “is a tricky question”.
“In the shorter term we think it [the bull run] will continue – albeit at a slower pace and with more muted returns,” he says. “In addition, worries over trade wars and rising interest rates have elevated the risk side of the equation.
“Longer term, we are nearer the end of the business cycle than the beginning, so investors would be prudent to consider their time horizons and how much risk they want to take.”
Advisers with clients who are preparing to go into decumulation will take a different view from those in the accumulation phase, for instance.
“Of course the bull run in US equities won't continue,” asserts Mr Cooke, “they never do, but when it will turn to a bear [market] is anyone's guess and plenty of people are guessing.
“History tells us most of them will be wrong and will continue to be wrong.
“What we do know is that when the bull run stops, the decline will most probably be short lived in relative terms, for anyone investing long term, over 20 to 30 years or more.”
He adds: “In fact, over that time scale they [investors] will probably go through two or three bear markets.”
Mr Cooke reassures investors the markets will recover and notes that US markets have shown strong returns over the long term.
He offers some words of warning though: “Anyone trying to guess the fall and then buy back in at the bottom would be better served predicting the lottery numbers.”
Buy and hold a long-term, globally diversified portfolio and that should include an exposure to US markets.
Much of the S&P 500’s performance has been buoyed by US large caps and, in particular, the Faang stocks – Facebook, Amazon, Alphabet, Netflix and Google.
According to Schroders, just as with the bull market of the 1990s, technology stocks have led the gains in the current bull market.
It reveals that $1,000 invested in the technology sector in March 2009 would now be worth $6,326 (£4,812), not adjusted for inflation.
The asset manager confirms the Faang stocks have been popular with investors.
It is likely that clients with either a US fund in their investment portfolio, or with any exposure to US equities at all across their investments, will be more exposed to US large caps than to smaller companies.
Mr Stammers says he has noticed that there is a tendency to focus on the larger-cap area in this region.
However, he confirms he holds large, mid and small-cap positions in US stocks.
Ignore the noise?
Marcus Brookes, head of multi-manager at Schroders, says there is a distinction to be made between the current bull market in US equities, and previous bull markets.
“During the tech boom, a small number of companies were on very high valuations. In today’s market, there are a far greater number of companies on high valuations,” he points out.
He is also more cautious about overall economic conditions in the US, explaining: “The problem is that the backdrop is actually one where the economic cycle growth rate has probably peaked, we have trade disputes and we have monetary tightening in the form of central bank stimulus being removed or interest rates being raised.
“It’s far from the perfect mix of conditions.”
So what does that mean for client portfolios?
Mr Brookes says: “In a low-return world, we don’t think this is the time to be overexposed to volatile assets that look expensive and which need good times ahead to justify their valuations. At this point, other, less volatile assets, such as cash, have their attractions.”
But Mr Cooke is more optimistic: “Long-term investors should ignore the market and manager noise; none of them know better than anyone else.
“Buy and hold a long-term, globally diversified portfolio - which should include an exposure to US markets.”
House View: Outlook for US equities
The current US equity bull market is closing in on a remarkable 3,500 days; a historic record. While valuations have certainly expanded as the cycle has progressed, equities are currently underpinned by an equally impressive cycle of corporate profitability.
The US has led the world higher. While all regions have seen very positive equity returns since the troughs of the financial crisis in March 2009, the US has been the best performing region, generating a total return of ~380 per cent(US dollar terms).
This has beaten European or emerging markets equities (both up around 180 per cent).
There are several possible explanations for the US’s outperformance. For a start, the economic backdrop has been very favourable. Something of a goldilocks scenario has developed, with solid economic growth, full employment and modest inflation.
However, countries like China or India have seen far superior economic growth, yet weaker equity returns.
Without doubt, one of the main contributors of the strength and length of the US bull market has been the resurgence of corporate profitability to historically unprecedented levels. Looking at the S&P 500, earnings per share have risen by almost three times over the past 10 years.
The icing on the cake was the significant tax cuts announced in 2017.
Net profit margins have reached 10 per cent and returns on equity is at 15 per cent, compared to 3 per cent and 5 per cent respectively in 2008.
Why has profitability of US firms been so much stronger relative to their global peers?
A major contributor has been the country’s unique position as the global leader in technology and innovation. Silicon Valley is often described as the global “cradle of innovation”, and is home to some of the world’s most innovative as well as profitable companies.
In addition, the US has been particularly successful in repairing its banking sector, resulting in US bank profitability far exceeding European peers.
Further, the US is home to a resurgence in oil production driven by a revolution in fracking technologies. Its relatively stable economic and political environment has attracted large capital inflows, resulting in a surge in the dollar.
The icing on the cake was the significant tax cuts announced in 2017.
Even so, there are several clouds which are gathering on the horizon. The Federal Reserve is in the process of reducing the assets on its balance sheet and interest rates are rising, albeit moderately. Corporations as well as governments have taken advantage of this period of cheap debt to increase their financial leverage. Rising interest rates, in combination with high levels of debt, can be a dangerous combination.
In addition, these high levels of corporate profitability - and resulting high levels of valuation - are dependent on the smooth functioning of economies and a frictionless flow of goods around the world, all of which could quickly be called into question by an escalating trade war.
Frank Thormann is a portfolio manager at Schroders