With the US stock market continuing to climb and hitting new all-time highs on a regular basis, many commentators, including the FundCalibre research team, have questioned whether US equities have become too expensive and if the US is still an attractive place to invest.
However, the US is a huge market – the biggest in the world – and the S&P 500, which we are all watching, is home only to the very largest companies in America. So we caught up with Mark Sherlock, portfolio manager of the Hermes US SMID Equity fund, which invests in medium and smaller US companies, to find out what he thinks and to see if there is value left in his part of the market.
“Valuations, whilst towards the top end of their trading range, reflect a healthy and improving underlying US economy,” he said. “This benign backdrop can continue to support earnings growth for some time and we expect will drive further market appreciation irrespective of stimulative fiscal and economic policies.”
Is the ‘Trump’ trade off the table?
“At a sector level, there has been a rotation out of some of the beneficiaries of the so-called ‘Trump trade’ (banks and industrials for example) into parts of the market like healthcare and technology, which relatively underperformed in the post-election euphoria of Trump’s pro-growth policies.
“This rotation reflected the weaker economic data coming through in February and March and acknowledged a realisation that many of Trump’s policies are controversial and will likely require compromise. These factors make for a better set up for the asset class – a market driven by fundamentals rather than one based on the expectation of political stimulus.
“With this in mind, the market now appears to be more broadly representative of the robust fundamentals which underlie it. At the company level, several industrial businesses have called the bottom, and the deflationary effect of energy’s decline has begun to dissipate. The recent earnings season produced the highest revenue growth since 2011 and in many cases earnings are being revised up, reflecting increasing business confidence.”
What is the case for US small and medium-sized companies?
“US small and medium-sized businesses typically earn 70-80% of their revenue domestically, compared with 50% for larger companies, and thus should benefit considerably from any enhanced US economic growth.
“Small and mid-cap companies have also historically outperformed the broader market in periods of rising rates – in particular the early stages, which tend to coincide with strong growth and a benign economic backdrop; a context in which we are currently operating.”
How do you identify opportunities in this area of the market?
“While the US small and mid-cap market is attractive, careful stock selection remains vital. We look for quality companies with high barriers to entry and a durable competitive advantage, bought below our assessment of their intrinsic value. We like companies that operate with defensible franchises, which can deliver consistent and stable earnings growth whatever the idiosyncrasies of the macroeconomic environment.
“Our large investment universe typically means it is possible to find interesting investments in all sectors. There is also a degree of information inefficiency in our area of the market, whereas information related to large cap businesses tends to be more commonly known. 53 analysts cover Apple. Some of our stocks aren’t covered by any sell-side analysts at all, which allows us to build a differentiated portfolio, increasing our potential to outperform.”
Are there any sectors you would like to highlight?
“In many sectors the disruptive effect of technology has never been more evident – retail, autos and media being examples of sectors where structural challenges continue to test the accepted norms. Active stock-picking allows for a more thoughtful allocation to these uncertain parts of the market. “The US retail supply chain is rapidly being disrupted – and this is creating opportunity. As large and small players alike compete for shoppers across channels, we prefer to invest in the enabling technology rather than the brands on offer, which frequently fall out of favour with consumers. “In supply chain software company Manhattan Associates, for example, we are not investing in a single consumer brand exposed to competition, but a business that is both enabling and benefiting from the growth of omni-channel sales: the ability to deliver goods to the consumer in-store, online or at click-and-collect desks in the most cost-effective way. Its software helps retailers optimise what is their most valuable and risky item of working capital – their inventory.”