In a manner befitting the country which remains the world’s greatest source of innovation and entrepreneurialism, however, the US economy has demonstrated great resilience.
Despite facing a significant headwind from fiscal tightening in 2013, GDP grew by almost 2 per cent, unemployment continued to fall, and both business and consumer confidence improved. Although the start of the current year will have been impacted by the extreme cold snap which saw even Hell freeze over (the one in Michigan), we are optimistic about the outlook for the US economy: fiscal drag will reduce in 2014; politicians are behaving more sensibly for the moment; and labour participation rates are beginning to improve.
Unfortunately for value investors, though, most of this already appears to be more than reflected in the valuation of US equities.
This does not mean that opportunities are impossible to find, but it may require investors to look further afield.
In the UK market, for example, it is possible to find companies that are exposed to very similar end-market dynamics as their US peers but which trade at a marked discount.
GKN, the leading UK industrial company, produces aerospace components and driveline systems for commercial vehicles.
Performance of stock versus index over 1yr
Source: FE Analytics
As a consequence, the company is exposed to two key macro drivers – global automotive production and the civil aerospace cycle.
Despite this, GKN is currently valued at around 12x current year earnings versus both US aerospace peers and auto supplier competitors, such as BorgWarner, which trade at a 30-40 per cent premium.
While each company must be judged on its own merits and weaknesses, in this case the scale of the differential appears anomalous.
The longer such valuation gaps persist; the greater the likelihood of US corporations with under-utilised balance sheets engaging in acquisition activity.
Somewhat surprisingly, the one area where US equities do appear to represent good value compared to their global peers is the pharmaceutical sector.
In recent years, investor concerns over patent expiries and declining R&D productivity have had a negative impact.
Pfizer, the world’s largest research-based pharmaceutical firm, however, has only a limited number of products going off-patent in the near future and should deliver continued growth in sales of existing products.
In addition, Pfizer’s late-stage pipeline is particularly exciting with a number of drugs in phase III trials or awaiting regulatory approval.
The group also is a prime candidate for a break-up, having recently reorganised itself into three divisions: an ‘innovative’ segment focused on patent-protected products; ‘VOC’ which will manage the company’s vaccine, oncology and consumer products; and ‘value’ which will focus on generic and biosimilar drugs.
Despite having outperformed its European peers significantly over the past few years, Pfizer is still valued at a 20 per cent discount to this group.
With a superior outlook and number of potential catalysts, we expect this outperformance to continue.
It has become a well-worn truism, but investors should always remember that economic growth and equity markets do not always move in lockstep.
Blindly investing in US equities because of a positive view on the wider economy may risk disappointment.
In recent years, US equities have performed remarkably well in the face of numerous crises; as the outlook improves they may be due a well-earned breather.