Despite US Federal Reserve’s chair Janet Yellen’s assertion that the case for raising interest rates had “strengthened”, it seems she might be more eager to find out who her next boss is going to be first.
As widely anticipated, the Federal Open Market Committee decided at its September meeting to sit tight and keep the cost of borrowing between 0.25 per cent and 0.5 per cent, although three members were against the decision.
However minutes from the meeting highlight that the majority of the committee anticipates a hike by year end.
Like the rest of the globe, the Fed is no doubt keen to find out what will happen on 8 November, when the US will decide whether former Secretary of State Hillary Clinton, or businessman and reality television personality Donald Trump, will be the next leader of the free world.
But election or not, the case for tightening monetary policy seemed weak on paper last month.
While the US has no shortage of external factors to contend with, not least the UK’s decision to leave the European Union, the world’s largest economy has been battling its own demons, including stubbornly low inflation and poor levels of growth. In the second quarter, its economy expanded at a rate of just 1.1 per cent, well below expectations.
More recently retail sales remained subdued during August while the US non-manufacturing index collapsed to 51.4 from 55.5 in July, again below market forecasts and the lowest level since February 2010. On the flip side, US unemployment has dropped from a peak of 10 per cent in 2009, to less than half that today.
Although the rate of employment growth has slowed over the past 12 months, the pace has been “relatively modest”, notes Capital Economics US economist Steve Murphy. He says: “In fact, monthly payroll gains have averaged a respectable 200,000 over the past 12 months and 180,000 since the start of the year.”
However, all eyes are now focusing on the Fed’s get-together at the end of the year, which will mark 12 months since it raised interest rates for the first time since 2006.
Notwithstanding the Fed’s indication that there will be a December rate rise, Architas investment director Adrian Lowcock believes investors should take this rhetoric “with a large pinch of salt”. He says: “The Fed had been expecting four rate rises this year. The decision to raise rates is dependent on a combination of US economic growth, stable stock markets and global macro-economic events, all of which have led the Fed to hold off its decision to raise rates in 2016.”
Lee Ferridge, State Street Global Markets head of multi-asset strategy, North America, broadly concurs, urging that the US will still need “a series of strong data releases between now and year end for the Fed finally to deliver”.
But despite Uncle Sam’s prevailing economic uncertainty, the Fed’s confusing indicators, and the dismal start to 2016, the US market has managed to soar. In August the S&P 500, Dow Jones and Nasdaq simultaneously hit record highs, a phenomenon not witnessed since the heady days of 1999. Overall, since the start of the year to the end of August, the S&P 500 has achieved a total return, in sterling terms, of 21 per cent – significantly ahead of the FTSE 100’s 12 per cent gain.
The US presidential election
However, markets have yet to contend with the election result. As of 22 September, poll aggregator RealClearPolitics showed a tight race, with Clinton 1.2 per cent ahead of Trump.
While the base case for many is that Clinton wins, recent history shows that it would be unwise to be complacent, given the level of shock that greeted the Brexit vote, a result many thought would never happen. Equally pollsters were way off the mark when it came to the UK’s general election in 2015.
The consensus view is that if Trump does pull it off, not only will the US be thrown into a period of grave uncertainty, but it is likely the rest of the world will feel it too.
Whitechurch Securities managing director Gavin Haynes says: “The initial impact of a Trump win would could result in a market shock of the magnitude of Brexit.”
Should Clinton emerge victorious, it is anticipated that the result would be a status quo development, and would be well received by investors – at least initially – in the level of certainty it would provide. As the big day looms closer, investors are naturally questioning what it could mean for US stocks.
Fiona Harris, client portfolio manager of the popular JP Morgan US Equity Income fund, thinks the likely implications are relatively limited. She says: “While it is possible for the Democratic party to regain control of the US Senate in this election, it is virtually assured that the US House of Representatives will remain controlled by Republicans, resulting in a gridlocked Congress, which has been the case for the last few years. The ability of any president, no matter the victorious party, to enact much significant policy action will therefore be limited.”
Matt Ward, co-manager of the Schroder ISF US Large Cap fund, adds: “Polls suggest a nod to Clinton and the Democrats. Should the odds of a Trump presidency increase, however, the increased volatility associated with his political inexperience and more fluid platform are mitigated by the reality that the importance of the President, from a reform standpoint, is somewhat overblown.”
Lombard Odier macro strategist Bill Papadakis believes a Clinton victory and the resultant policy framework would be similar to President Obama’s and the goal of preserving policies already in place – such as the Dodd-Frank bill or the Affordable Care Act – would be an important part of the new administration’s agenda. He warns though that a Republican-controlled House would prevent aggressive reform proposals from becoming policy.
He says: “Recent experience has shown how a divided and increasingly polarized government tends to result in stalemate. Secretary Clinton’s most ambitious plans for a large-scale infrastructure investment program and any expectations for a major dose of stimulus are therefore likely to be disappointed.”
While traditionally investors have preferred the pro-market stance of the Republicans there are big questions over Trump’s policies, not least his foreign policy.
Some have suggested Trump’s plans for the US economy have crossed into the realm of fantasy. In a speech in September, Trump proposed broad brush tax and deregulation policies that he said would allow the US economy to expand at some 3.5 per cent a year, up from the current 2 per cent trend, creating 25 million new jobs over the next decade and generating additional tax revenues to pay for new infrastructure.
Trevor Greetham, Royal London Asset Management head of multi asset, says that while Trump’s policies sound great, they are “barely credible”. He says: “The forecasts are about as upbeat as you can get away with without crossing the line into make believe. The only way to get this kind of growth and job creation without inflation rising out of control is to boost the productive capacity of the economy and that is easier said than done.”
Whatever the outcome, the US is set to remain a hotbed of investment opportunity, with Rathbones’ chief investment officer Julian Chillingworth still relatively upbeat on its long-term investment potential. He says: “We have liked the US for some time. In the medium term the market has a great number of attributes; it is entrepreneurial and it has a great number of big players. But it is not cheap.”
Valuations appear rich on several measures. For example, the Shiller price-earnings ratio, which looks at the latest earnings and prices of the S&P 500, was trading at multiples of near 27x as of 21 September.
AXA Investment Managers senior economist David Page says: “The last time we observed such elevated valuations in a rising market was in the late 1990s/early 2000s when the technology euphoria overextended valuations.”
This year has been characterised by a strong rally in defensive sectors. In the first six months of the year, telecoms and utilities rose six times more than the rest of the market, and year to date they are the two top performing markets within the S&P 500. Many would argue this is symptomatic of the so called ‘bond refugees’ chasing income.
Henderson Multi-Manager Income & Growth co-manager James de Bunsen, who has been underweight the US, primarily as a result of the lofty valuations, asserts that this trend hardly shows great conviction in terms of people expecting growth in the economy.
He says: “In a world where interest rates are expected to go up, it is a sign of people’s unquenchable thirst for yield.”
Chelsea Financial Services managing director Darius McDermott describes the US market as “very tricky”. He says: “For valuations to remain this high, earnings need to keep up and it they do not you could see that there might be a pull back. When the backdrop is expensive, you cannot afford for negative sentiment to creep through.”
Page adds: “Analysts’ estimates of 11 per cent earnings growth are ambitious and downward revisions are likely. US earnings growth has now been negative for the last four quarters and the recent rise in unit labour costs does not bode well.”
But in terms of corporate earnings growth, Harris expects it should be a positive year for the S&P 500, as the significant headwinds from the stronger greenback and the lower price of oil have abated.
In all, she anticipates 2 per cent growth in 2016 at the aggregate level but 5 per cent growth excluding energy.
Looking ahead, Ward says that against a more modest GDP/top-line backdrop, he believes “scarcity value” will accrue to those stocks where companies grow more quickly and as such he is overweight consumer discretionary and technology. Ward is confident in regards to the backdrop for US equities in 2017 and projects high single digit annualised US large-cap returns.
Right now he counts Facebook, Apple and Amazon in his top holdings. He says: “We are trying to avoid those so-called ‘bond proxies’ with lacklustre growth and higher valuations bid up in the quest for yield. While we respect the need for defensives amid a cross-current of flagging global growth and uncertain policy response, we need positive earnings revisions and a clear thesis to make any investment decision.”
For his part Jupiter North American Income fund manager Sebastian Radcliffe has also eschewed the bond proxies such as utilities. He says: “We would avoid all these and we feel investors are likely to be much better served by more value-biased areas of the market.”
Within his top 10 holdings, he holds pharmaceutical company AbbVie as well as insurance giant AIG and Bank of America. He says: “We have significant positions in companies that are not only historically cheap but also historically under earning. Many of these – such as a number of our financial holdings – are beneficiaries of rising rates that are likely to go one way from here.”
Although the US market has delivered a robust performance, investors have very much been in retreat, reflecting the wider trend of redemptions, which have plagued 2016. Numbers from the Investment Association show that between the start of the year and the end of July, the North America sector has endured a net outflow of more than £446m. However, at the same time its assets under management have actually swelled from £37.8bn to £43.8bn, reflecting the market and fund performance. Cash has not flooded into US trusts either, where discounts in the AIC’s North American category have remained relatively stationary year-to-date, with the typical fund trading at -9 per cent.
But whatever the backdrop, the US stock market remains the bellwether of the developed markets. As Worldwide Financial Planning independent financial adviser Nick McBreen says: “The US equity market is a mature and powerful force and while sectors like housing blow hot and cold the overall message has to be that you need some exposure to the US in any portfolio.”
While bond proxies may not be the best bet right now, FE head of research Rob Gleeson highlights that investors need to bear in mind the potential currency play to be had. He says: “If you have rising rates in the US and falling rates here – the dollar will continue to strengthen. That will make North America attractive for UK investors and for this reason.”
Whether investors want to go active or passive there is no shortage of portfolios on offer. For those more interested in the latter, Whitechurch’s Haynes suggests Legal & General’s US Index fund, which tracks the FTSE USA Index, and comes with an ongoing charges figure of 0.1 per cent. Tilney Bestinvest backs Vanguard’s US Equity Index fund, which echoes the S&P Total Market benchmark, and also charges 0.1 per cent. For an even cheaper option, at 0.08 per cent there is the HSBC American Index that mirrors the S&P 500. Lowcock recommends BlackRock’s North American Equity Tracker, which echoes the performance of the FTSE World North America Index and levies an even lighter 0.07 per cent.
In terms of active plays, Square Mile’s senior investment research analyst John Monaghan and Chelsea’s McDermott both cite Legg Mason ClearBridge US Aggressive Growth. Managed by Richie Freeman and Evan Bauman, it has a bias towards the information technology and healthcare sectors and is up by 124 per cent over five years to the end of August. McDermott says: “We believe the long-term high-conviction approach, combined with the size and strength of the team, make this a compelling option for investors looking for US equity exposure.”
Monaghan also rates the lesser-known Dodge & Cox US Stock fund which comes with an OCF of 0.7 per cent and is up by 141 per cent over five years. He says: “The portfolio is usually based around a core of quality, steady growth stocks but more cyclical or higher growth stocks will be considered if the valuation is deemed attractive.”
Fidelity American Special Situations, which is managed by Angel Agudo is one of McBreen’s favourite plays in the sector. The fund, which has around a quarter of its assets invested in tech stocks and carries an 0.95 per cent ongoing charge, has delivered a 167 per cent return to its investors over the past five years. McBreen says: “It is a good example of a fund that has an excellent track record and can trawl the sector for those nuggets of investment potential.”
From an investment trust perspective, Lowcock backs JP Morgan American, which is up 118 per cent over five years and charges 0.69 per cent. Lowcock says: “This is a solid core US fund. Manager Garrett Fish is very experienced and is adapt at combining the fundamental stock analysis with the insights produced by JPMorgan’s behavioural finance unit.”
For those who want to avoid a pure US play and wish to take a more broad-stroke approach, Lowcock also tips Scottish Mortgage, which has around 50 per cent invested in the US and charges 0.45 per cent. Over five years it has delivered a total return of 139 per cent. Lowcock adds: “The managers have a strong focus on high growth long-term investments and believe the US technology companies have long-term potential.”
Active versus Passive
If any market has been the focus of the prolonged and still ongoing passive versus active debate, it has been the US. Fans of passive funds argue that the market efficient and a cheaper tracker fund is the better option for most investors. Hargreaves Lansdown head of research Mark Dampier admits that the US has “proved incredibly difficult for active managers to consistently outperform”.
Architas’s Lowcock agrees. He adds: “It does not surprise me that passives often beat active funds in the US. There is this almost ‘perfect access’ to information. It is very difficult for active managers to get an edge.”
Even the world’s most famous stock picker Warren Buffett has on many an occasion waxed lyrical on the virtues on passive investing when it comes to taking on the US market. He even went as far as to say that his widow’s retirement fund should have a hefty allocation to a cheap S&P 500 tracker.
Certainly the numbers back up the Berkshire Hathaway boss’s sentiment. Numbers from Square Mile Research and FE Analytics show that within the IA’s North America sector, the average passive portfolio has beaten the typical active fund performance over the one, three, five, seven and 10 years, to 31 August. For example, over five years, the average active vehicle has delivered a return of 123 per cent while over the same period the mean passive performance has been 135 per cent.
However that is not to say that some active funds have not delivered strong aggregate returns. Take Fidelity American Special Situations, which is up by some 167 per cent versus the S&P 500’s 139 per cent for the period while Old Mutual North American Equity is up by 157 per cent. Over three years, the market has delivered 64 per cent, while the T. Rowe Price US Large Cap Growth Equity fund has achieved a superior 87 per cent.