Can US stocks continue to defy economic gravity?
The S&P 500 and the US economy are at odds with each other. While the former has almost recovered pre-crisis levels, the latter is officially in recession. Ahead of Independence Day, four investors discuss the implications of such an unusual situation and whether there is still opportunity in US markets.
Eric Papesh, US equity portfolio specialist at T. Rowe Price
US equities have rebounded sharply from the lows reached in March, the broad market rallying some 40-45% from the low point. At the same time, the US economy has declined meaningfully. If we think of the equity market as a forward-looking mechanism, then there is clearly a lot of optimism currently being priced in, with investors seemingly prepared to look beyond the near term to a post-crisis recovery.
Our view is that, over the coming months and quarters, the US equity market is likely to experience a higher level of volatility than we have generally been used to over recent years. This will be in line with the information coming through about progress, or lack thereof, in fighting the pandemic. However, longer-term, we do not anticipate a continuing and persistent disconnect between the US equity market and the underlying economy.
We used the heightened volatility to buy various companies that had been oversold in our view. As an active manager, we are always looking to take advantage of these kinds of market dislocations in order to create alpha for our clients. The increase in activity in recent months has included dipping into certain companies in industries that are under extreme pressure as a direct result of the pandemic. For example, financials have suffered across the board as a direct result of the coronavirus, and this is creating some interesting opportunities on a longer-term view.
Erik Knutzen, CIO – multi-asset at Neuberger Berman
Instead of losing eight million non-farm jobs in May as expected, the US created 2.5 million. Retail sales jumped by a record 18% and Purchasing Managers’ Index (PMI) releases showed activity picking up faster than anticipated.
While some of these headline growth numbers have been remarkable, it is important not to be misled by low-base effects or to confuse a strong recovery with a full one. Two and a half million jobs in the US is great news, but we need almost 10 times that to get back to the unemployment levels of four months ago. PMIs have rebounded, but most indicate activity is still contracting, not expanding.
Once the new equilibrium is established, pre-crisis conditions of low growth, low interest rates, low productivity and high debt are likely to be compounded by even higher debt, even lower rates, higher taxes, tighter regulation, lower consumer confidence, ongoing social distancing and travel restrictions, and, potentially, a steep cliff edge on the other side of the current fiscal stimulus.
Nevertheless, we still think there is a case for tilting toward more risk, on a medium-term view. Given the scale of the stimulus and the shoring up of household and corporate balance sheets, our estimate of the floor for the S&P 500 in the event of an L-shaped outcome is higher now than it was three months ago.
Giles Money, global equities portfolio manager at Sarasin & Partners
More than any other region, the US is dominated by ultra-cap companies, which are digitising the world at a rapid pace. Apple, Amazon, and Microsoft are all well over $1trn in market cap, with Alphabet (Google) not too far behind. They are all highly cash generative and, more importantly, have places to invest this cash. Estimates show technology is responsible for more than 33% of US capital expenditure and is a large component of GDP growth.
While many argue the advent of new regulation and taxation systems for these companies will stop the deployment of capital and subsequent growth for these businesses, we are still finding valuations we are comfortable with, due to the positive backdrop relative to other much more challenged industries going forward.
Where economic growth rates are low, the share of thematic and structural growth rises. This leaves us with an increasingly thematically driven world. Digitalisation, which is one of our five key themes at Sarasin & Partners, has likely accelerated as a result of Covid-19 – with e-commerce up close to 70% year-on-year in the US. The question from here will be around which behaviours last, but what is clear is the US has many structural advantages.
Anu Narula, head of global equities at Mirabaud Asset Management
We are at the start of the US economic cycle, not the end. What has been different about this cycle so far is leadership within the stock market. Linked with the relatively flat yield curve and technological acceleration we are seeing, cyclicals have lagged – until recently. Going forward, we continue to think leadership can come from cyclicals, as their total addressable markets are growing.
PayPal or Nvidia are great examples, where the former is seeing increased use even among over 70s, who are online grocery shopping in many cases for the first time. Nvidia graphics processing units are increasingly being used for gaming, and the company is benefitting from the broader move to artificial intelligence. These are secular trends which will continue in the long term. While these companies look expensive on headline measures, the market often underestimates the ‘E’ of P/E.
On the other hand, there are good quality franchises within the recovery bucket – which is different in this cycle given the nature of the pandemic. One thing we were quick to recognise was consumer cyclicals can fulfil the same function in a portfolio which energy or industrials did in previous cycles. Over the long term, they are also better quality franchises. Such examples include TJX, Starbucks and Home Depot.
We believe there will be a rotation between these buckets as we move out of the recession, and we want to ensure a balance between both. We invest thematically, and many themes like explosion of data and platform companies, as well as health and well-being have accelerated in the last few months.