There are still good reasons to invest in US equities at the moment, although a particular focus should be paid to cyclicals at this stage of the cycle, according to JP Morgan Asset Management’s Christian Preussner.
The chief client portfolio manager of US equities admits that it’s been more of a mixed earnings season in the US so far but he believes that there are enough tailwinds for investors to stick with US equities.
His view comes at a time when investors are beginning to question whether companies in the world’s largest economy are still good value, following the S&P 500 index’s seventh consecutive year in a bull market.
Over the last three years, the index has achieved returns of 67.76 per cent, which is 10.27 percentage points more than the MSCI World index and 26.03 percentage points more than the FTSE All Share.
Performance of indices over 3yrs
Source: FE Analytics
While there is no doubt the market has performed well, headwinds such as the drop in oil price, weak export markets and a strong dollar have made some investors wonder whether the market is overvalued.
However, Preussner believes that, overall, valuations are in fair territory and are neither cheap nor expensive.
“At 17x price to earnings relative to a long-term average of about 16x, we don’t feel this is overly stretched, particularly relative to bonds, which continue to look extremely expensive,” he said. 
“If you were to drill down to the sector level, utilities, telecoms and consumer staples are very much overvalued and that is pushing up the index overall, whereas financial services and IT are still below their long-term averages.”
Despite feeling reasonably comfortable with valuations, Preussner warns that investors should still avoid the highest-yielding stocks and instead focus on companies with an emphasis on growth.
“Investors have to be selective in their exposure,” he added.
Andy Parsons (pictured), head of investment research and advisory services at The Share Centre, also believes that investors must tread carefully. While he likes the US biotech and technology sectors, he thinks that valuations are ahead of themselves in many US companies.
“In terms of the US market overall, we’re slightly wary. We’re sitting, holding and waiting. We think markets are a little high. There’s been some real strength in the US over the last few months and valuations are not massively stretched, but there aren’t huge pockets of value out there,” he explained.
“In the key areas we like out there, we’re a little bit more apprehensive. It wouldn’t surprise us if we saw a bit of a pull-back.”
“On that basis, we’re not selling down from the US, but what we’re not doing is going significantly overweight. If we saw pockets of opportunity through a pull-back, we would maybe trickle a bit of money in, but it would only be on market weakness.”
Nerves towards the US equity market are also shared by Ryan Hughes of Apollo Multi Asset Management, who is slightly put off by how expensive the market looks in comparison to other investment opportunities.
“Many companies seem to be propping up their share prices by borrowing cheaply in the bond market and then using the capital raised to fund share buybacks, thereby financially engineering share price appreciation,” he said.
“That said, pockets of the US market look better value and therefore we are comfortable playing certain areas of the market.”
However, it isn’t just high costs that are deterring investors. The strong dollar is a potential headwind that could further tarnish the appeal of the US equity market.
This doesn’t just impact investment returns – US companies that operate multi-nationally could see a drag on earnings due to a decrease in the dollar value of international revenues.
Parsons said: “It’s the main leading indicative currency, so the strength of it does play out. It can work one of two ways.”
“With any currency and the strength of it, it can work for and against companies, it all depends whether you’re an internal or an external.”
“The strength of the US dollar will hurt, and it’s beginning to hurt. It will naturally start to feed through and we’re beginning to see that impact on earnings.”
Preussner acknowledges that the dollar’s strength creates an uneven playing field and that this is impacting earnings. However, he believes that this impact differs when viewed at a company level, even for predominantly multinational companies.
“Foreign sales exposure is a significant issue for major multinational companies that have international revenues impacted by the stronger US dollar,” he admitted.
“For example, information technology has about 60 per cent of earnings from outside the US and materials about 50 per cent outside the US, as an investor might expect the stronger greenback to hit the earnings results for these companies.”
“However, if you drill down to the stock level in the information technology sector, for many companies the earnings are factored in US dollar currency as opposed to local currency, significantly limiting their exposure to currency translation effects.”
While this erosion of revenue has still hurt many US company giants, the low oil price has kept costs down for many stocks across cyclical sectors.
However, this means that it’s more important for investors to get under the bonnet of their funds than ever.
Hughes said: “The drop in the oil price is in some ways a huge boost for the US given its overall energy needs as an economy, but clearly oil related companies have been a part of the drive up in the US market.”
“For investors considering the US, this shows the need for looking at an active approach that can invest away from the index which contains large exposure to companies impacted by the falling oil price.”
“We have continued to play the US through exposure to technology companies, which has kept us insulated from the large fall in oil related companies.”
Performance of sectors over 1yr
Source: FE Analytics
While many investors are steering clear of the energy sector altogether, Preussner believes that this doesn’t necessarily have to be the case.
However, the huge weighting that the energy sector has in US markets means that a close eye should be kept on US investment vehicles.
“The energy sector makes up around 12 per cent of overall S&P 500 2014 earnings and those earnings are expected to drop by approximately 50 per cent in 2015, in reaction to the halving of the oil price since the middle of last year,” he said.
“We are therefore cautious on the energy sector and are actively seeking companies and sectors are meaningful beneficiaries of lower oil prices, such as airlines.”
While it may seem that there are still some opportunities in the US market, many investors are starting to adopt a change in tactics.
In the past, investors have viewed the US as an area where actively-managed funds have struggled, due to the extreme efficiency of the market.
However, because of the potential pitfalls and variations in the market at present, Parsons believes that it’s now far safer to invest in actively-managed US funds.
“The global picture is we’re still fragile. Everybody looks at the US as the bellwether. A lot of people look at it as the lead indicator, and I think we just have to be wary,” he said.
“There are opportunities out there but sometimes, what you tend to find, is that when a topic becomes very hot or people get very excited about it and want to be part of it, that’s where they help to start to drive up the valuations and things become overpriced.”
“That’s where the markets can get ahead of themselves. So it’s just saying to people that those themes will still be here tomorrow, there’ll still be here next month, they’ll still be here in two years’ time. They will be the key investable themes over the next few years.”
“It’s a case of not rushing [into US investments], you have to take things slowly.”