Stretched valuations, political uncertainty and a return to normalisation for the Federal Reserve pose challenges for US equity markets, but active managers are confident that investment opportunities remain.
Typically a day of reflection, Thanksgiving can provide investors with time to think about the US equity market as they remain closed over the holiday period.
Last year’s Thanksgiving came after the election of Donald Trump as US president, a move particularly welcomed by markets and saw the index rise by 4.32 per cent during November.
However, as the US market takes a break, several challenges remain on the horizon for investors.
Indeed, Trump has faced a number of political challenges since coming to power and now must collaborate with legislators to pass his ambitious tax reform plans.
It also comes at a time when US equity valuations have remained high despite concerns over a correction and the impact a return to central bank policy normalisation will have on markets.
Performance of S&P 500 over 10yrs
Source: FE Analytics
SYZ Asset Management’s chief economist Adrien Pichoud said as the US economy has continued growing steadily, future economic policy has become the main source of uncertainty.
“On the fiscal side, the dreaded deadline for the debt ceiling has been pushed to December, to avoid badly‐needed hurricane relief funds being stuck in the current Congressional quagmire,” he said.
“But the debate will come back and, with it, the recurring issues of promised tax cuts, infrastructure spending and healthcare reforms that have so far disappointed expectations.”
Additionally, Pichoud said the Federal Reserve’s start of the long-anticipated reversal of quantitative easing and further expected rate hikes have also started to have an impact.
Below, US equity managers reveal to FE Trustnet how they feel about the market this Thanksgiving.
Despite elevated market valuations, some fund managers are bullish about the outlook for US equities.
Ed Cowart, manager of the offshore Nordea 1 – North American All Cap fund, said while today’s valuations may be slightly above long-term historical averages they are still within normal range given the low interest rate environment.
“We also believe it is important to consider where we are in the business cycle – as equity valuations tend to follow the path of leading economic indicators, which are still improving,” he said.
“Additionally, some sectors of the market have become somewhat expensive, but others still appear very attractive.”
Yet, Cowart said there were a number of risk factors for markets currently despite the positive economic and market data.
Cowart highlighted geopolitical uncertainty, unwinding of quantitative easing by central banks and political gridlock in Washington.
“Weighing the data, we believe the most probable scenario is for the US economy to maintain its slow, but sustainable, growth,” he added.
US GDP over 10yrs
Indeed, Michael Russell, manager on the Hermes US All Cap Equity fund, said the US “has an opportunity to emerge from the low inflation, low growth trend of recent years”.
As such he remains more positive on the corporate sector and particularly small businesses following last year’s election.
“The key to unlocking this demand might be changes to corporate tax related to President Trump’s tax reform plan,” said Russell.
“At the same time, market valuations have moved up to the high end of historical averages supported by a benign environment for credit.”
Russell said he expected further gains to be driven by earnings growth, highlighting the importance of active management and stockpicking ability.
Indeed, Richard Nackenson, portfolio manager of the Neuberger Berman US Multi Cap Opportunities fund, said active managers could fare particularly well in the current market environment.
“Reasonable stock valuations, moderate and steady growth in the US economy and strong corporate fundamentals suggest equities remain a sound long‐term investment,” he said.
Nackenson said companies with strong levels of free cashflow were particularly attractive, given their ability to allocate capital in more value accretive ways.
“Management teams have a significant opportunity to create value for shareholders by allocating capital effectively,” he explained.
“Dividend increases, share repurchase programmes, cash accumulation, debt retirement, organic growth initiatives, selective and highly accretive acquisitions – all can accrue to the benefit of equity holders.”
Stockpicking ability is likely to become increasingly important as the outlook for the US market becomes less clear and with seemingly little further space for stocks to rise.
Jeff Rottinghaus, portfolio manager of the five FE Crown-rated T. Rowe Price US Equity fund, said: “Given the relatively full valuations in today's market, it is getting more and more difficult to identify attractive investment opportunities.
“In recognition of this, and the fact that we are far along into the current economic cycle, we believe a more cautious approach is warranted.”
The manager employs a bottom-up process, targeting opportunities irrespective of investment style in the $420.4m T. Rowe Price US Equity fund.
The large-cap biased fund has returned 60.03 per cent over three years, compared with a 55.25 per cent rise in the S&P 500 index and a 49.35 per cent gain for the average IA North America sector fund.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Rottinghaus added: “We believe careful fundamental research will be necessary to find opportunities and we will continue to search for investment opportunities in select areas of the market, utilising our bottom‐up stock selection approach.”