US equities have continued to perform better than other developed markets so far this year, even after the March coronavirus sell-off. And asset allocators are beginning to take notice.
Huge levels of support from the Federal Reserve has buoyed the market – despite the ongoing economic ramifications of coronavirus – and caused share prices to rise.
Year-to-date, the S&P 500 has made a loss of 3.07 per cent – in US dollar terms – outperforming the MSCI ex-USA index which is down 9.74 per cent.
Performance of indices YTD
Source: FE Analytics
And asset allocators have begun to increase allocations to US stocks with the closely watched Bank of America Merrill Lynch Global Fund Manager Survey showing that allocations jumped by 9 percentage points in May to a net 24 per cent overweight position.
The world’s largest asset manager – BlackRock – is among those that has recently changed its stance on the US market, recently upgrading its stance on US equities from ‘neutral’ to ‘overweight’.
It explained that with “ample policy space on both the monetary and fiscal sides” there was room for US stocks to weather the coronavirus shock better than other developed markets.
The asset manager noted that it has found opportunities in the US from both a strategic and tactical standpoint given the policy outlook and the quality tilt of the market.
As such, there are both longer- and shorter-term opportunities available for investors.
From a strategic view, investors considering a return to US equity should look beyond fiscal stimulus to identify long-term opportunities.
“Cash-rich companies are attractive in the current environment, as they are less likely to draw on US government assistance and are not constrained by future buybacks or profitability measures compared to their leveraged counterparts,” the asset manager said.
“This is a fairly defensive approach, which may be preferred by some investors given the steep US coronavirus case trajectory.”
According to BlackRock, companies with higher cash balances will have greater liquidity to withstand lockdown conditions.
“The level of cash on a company’s balance sheet is also a metric for its relative quality – a factor we favour in the current environment,” it added.
Based on index analysis, the asset manager found that information technology and communications were the least indebted sectors with strong cash balances.
“Both the [tech heavy] Nasdaq and the tech sector itself held up relatively well in the recent downturn compared to broad US equities,” it noted.
As the below chart shows, the Nasdaq composite has made a total return – in US dollar terms – of 7.65 per cent compared with a loss for the S&P 500 index.
Performance of indices YTD
Source: FE Analytics
Focusing on tactical positioning, the asset manager highlighted the opportunities to be found in the healthcare sector against the worst pandemic in more than a century.
“The US healthcare sector – aside from holding up well defensively – has increasingly been bought by investors seeking to capitalise upon coronavirus-driven demand for medical devices and services, with over $5bn added so far in April to global ETPs [exchange-traded products] alone,” it noted.
“Flows into the sector are on track to be the highest since president Donald Trump was elected in November 2016, and the highest on record.”
BlackRock noted that, on a valuation basis, healthcare stocks typically trade at a discount to the S&P 500 and have continued to do so in 2020. They have also not participated in the snapback observed in markets since the March sell-off.
“Healthcare is cheaper than the broad index while debt levels are in line with the average,” said the asset manager. “The sector has historically had a low beta to global growth, adding diversification benefits.
“However, volatility may be elevated going into the upcoming US election, given the contentious nature of the subject in US politics.
“Longer-term, the inelastic nature of healthcare demand, which feeds into its low beta to growth, could boost profitability as the backlog of deferred non-coronavirus procedures are undertaken; this may offset the drop in short-term revenue.”
Another sector that has fared well under lockdown, said the asset manager, was communications, which has been boosted by the popularity of some of its constituents and media-streaming constituents, such as Netflix.
“The tactical opportunity here is more nuanced,” said BlackRock. “The bullish case focuses on an increase in streaming revenue over a prolonged lockdown period.
“On the other hand, the interactive media and services sub-sector makes up almost half of the index, so a drop in advertising revenue could weigh on the constituents’ profitability.”
From an income perspective, the coronavirus has also seen some different behaviours emerging again favouring those with strong balance sheets and other quality characteristics.
“During past growth shocks, we have seen investors flock to quality exposures,” the asset manager noted. “The approach this time around has been slightly different.
“Amid the swathe of dividend cuts announced across the market, and increasing pressure on companies to refrain from using state assistance funds for dividends, some investors have gravitated towards companies with large and stable dividend payouts.”
It added: “For income, we prefer to screen dividends for quality, filtering companies which measure highly on metrics associated with financial health and dividend sustainability.
“These screens may help income-seeking investors avoid falling into value traps.”