US equities have been downgraded to ‘negative’ by strategists at Pictet Asset Management as a number of factors are increasing the risk that the market will be knocked off its lofty valuations.
The US stock market has been powered ever higher over much of the past decade after growth sectors such as technology benefitted from historically low interest rates. However, this has been tested more recently.
Soaring inflation on the back of post-lockdown supply bottlenecks and the Russia/Ukraine war mean the market is expecting a series of interest rate hikes from the Federal Reserve and other central banks. Higher inflation and weaker consumer sentiment makes Pictet anticipate weaker-than-expected global growth and a hit to corporate earnings.
Luca Paolini, chief strategist at Pictet, said: “Against this backdrop, we downgrade US equities to negative. A growth-oriented market with the most unattractive valuation in the world, we think US stocks are likely to bear the brunt of the adjustment, with sectors sensitive to interest rates and economic cycles especially under pressure.
“That said, we don’t think an outright negative stance on equities is warranted. Investor morale is bouncing off very depressed levels, offsetting deteriorating fundamentals at least in the short term. We therefore remain neutral on equities and bonds.”
Pictet’s asset allocation grid – April 2022
Source: Pictet Asset Management
Paolini noted that US stocks have been resilient to the economic fallout of the conflict in Ukraine, recovering more quickly from the initial sell-off caused by the invasion than many other markets. The S&P 500 has outpaced the MSCI World by around 5 percentage points over the past three weeks.
However, he added that this recovery “looks difficult to justify on several counts”.
Firstly, he doesn’t expect US corporate earnings will rise as sharply as consensus forecasts are expecting. Pictet said profit margins will fall from their all-time high of 13 per cent because of wage increases and higher input costs, while reducing its earnings growth forecasts for US firms from 15% to 9%.
The asset management house also flagged US stocks’ earnings multiples as looking “lofty”. This would be a risk if the Federal Reserve was forced to speed up the pace of interest rate hikes in its bid to curb inflation, which is now at a 40-year high.
“In that scenario, the US market’s relatively high exposure to growth stocks becomes a vulnerability. In other words, US stocks’ earnings multiples could contract more sharply than most other markets, bearing the brunt of the global equities’ adjustment to higher interest rates,” Paolini explained.
“This, and the fact that US equities are still the most expensive on our scorecard, has led us to downgrade US stocks to underweight from neutral.”
However, Pictet added that there are some areas of the stock market that look attractive at the moment, with the UK being one.
Thanks to the UK’s mix of cheap defensive and commodity-oriented companies, the investment house said the prospects for UK equities look “encouraging” and it remains overweight.
“We also believe Chinese stocks are good value and hold a higher-than-benchmark exposure in this market too,” Paolini said.
“While China’s equity markets remain susceptible to shifts in Beijing’s regulatory regime and a possible slowdown in economic growth, valuations have declined to a point where such risks appear fully discounted. Chinese stocks’ earnings multiples are close to their widest ever levels compared to those of their global peers.”