Strong earnings growth has powered the rise of US equities over the past few years.
The most recent deregulation push by the US administration, together with corporate tax changes, has led market observers to expect a continuation of positive earnings news from US companies. This has driven equity markets higher still, leading to stretched valuations for many US stocks.
Equity markets are likely to have to walk a tightrope, supported by continued positive earnings news, but also having to contend with high valuations and rising interest rates, according to Citywire AA rated Ian Heslop. He said this is in view of the tightening of the US economic policy.
Heslop, who manages the Old Mutual North American Equity fund, said the fund overweights themes that are expected to outperform, given the market environment that we can measure.
‘As we move into the second half of the year, the fund is generally more defensively positioned, as investor sentiment has become less positive and markets have become more unstable,’ he said.
However, given the level of uncertainty going forward, the fund is reasonably well hedged between themes that are likely to perform well in a volatile market as well as bullish equities markets.
Citywire A-rated Larry Puglia, portfolio manager of T Rowe US Blue Chip Equity fund, said the fund outperformed its benchmark primarily due to stock selection in the consumer discretionary, information technology and health care sectors.
The fund, which has returned 51.7% over the past three years, has had significant exposure to the three sectors over the past several years and they remain the fund’s largest allocations.
‘We believe these sectors offer the most fertile ground for innovation and growth,’ he said.
Meanwhile, the fund remains cautious with structurally challenged industries and defensive sectors such as consumer staples. These sectors appear to have limited growth prospects and face secular headwinds from e-commerce and private label competition.
‘At this late stage in the economic cycle, we believe that valuations are rich in cyclical areas including industrials and business services and materials,’ Puglia said.
The fund intends to maintain its underweight exposure to those sectors.
He added: ‘We have zero allocations in the telecommunication services and energy sectors – a decision that modestly hurt our relative returns.’
Citywire A-rated Matthew Benkendorf is another manager who is positive on the consumer discretionary sector.
The fund allocates about 25% of its assets to the consumer discretionary sector, which is now the largest sector exposure for the fund.
Meanwhile, the fund’s allocation to consumer staples companies, which had been the portfolio’s largest sector exposure for several years, is still substantial at 20% of the portfolio’s assets.
Benkendorf, who manages the Vontobel Fund - US Equity, said the fund has increased its weighting in the materials sector and reduced the portfolio’s allocation to information technology over the last few months.
Mind the value gap
Citywire A-rated Daniel White said there is currently a wide valuation gap between the cheapest and the most expensive stocks in the market.
The spread is almost as wide as at the time of the technology bubble in 2000.
‘In our view, value stocks look attractive on an absolute and relative basis, and a wide range of opportunities can be found across the market,’ he said.
White, who manages the M&G North American Value A Inc fund, remains broadly positive on the medium-term outlook for US equities, but recognises there are a number of potential challenges and uncertainties.
Recently, large tech-related companies such as Apple and Amazon, have performed well and have been major drivers of the market’s gains. In contrast, cheap, out of favour stocks have been ignored.
One area where we see attractive opportunities in the US market currently is among ‘value’ stocks.
White’s fund takes third place in our risk-adjusted ranking of the sector’s strongest players over the last three months.
Despite near-term choppiness in the equity markets, Citywire AA-rated Patrick Dunkerley, said the outlook for US equities remains positive.
Dunkerley manages the OYSTER US Selection C USD fund, which returned 38.71% over the past three years, compared with the sector average of 26.78%.
‘We are optimistic about health care fundamentals due to strong company-specific growth, demographics-driven demand and exciting innovations,’ he said.
Meanwhile, the defense industry is favored under the current administration and augurs well for equities with exposure.
Dunkerley said the fund is also tuned into the changes in consumer behavior, which is more focused on experiences including travel and entertainment.
This article was published in the September issue of the Citywire Private Wealth magazine.