Is there any value in US equities?

Having experienced the fastest bear market in history, when it took just 22 trading days for the US stock market to fall 30%*, we have now experienced the fastest recovery in US equities since the 1930s**. The S&P 500 is not far off its record highs, while the economy added some 4.8 million jobs in June – well above analyst expectations after 22 million jobs were lost in March and April***.

But pessimists – and there are many – believe there is a difference between the resiliency of the markets and the actual economic outlook.

That is being tested at the moment, with results from the US earnings’ season for the second quarter of 2020 coming in thick and fast. These updates from corporate America should show us the full effect virus-induced lockdowns have had on US balance sheets.

What has the US earnings season shown us so far?

According to figures from FactSet, S&P 500 companies are projected to report a 43% fall in profits from April to June 2020, as well as a 10% drop in revenues. Net profit for these companies is expected to be the lowest since the first quarter of 2009.

However, aided by unprecedented stimulus from the US central bank, figures so far have been reasonably promising. Of the 20% of S&P 500 companies that have produced quarterly updates so far, around 80% have posted figures above analyst expectations. FactSet says they are reporting earnings which are 13% above estimates.

But with dividend payments down and very few companies able to give solid long-term outlooks given the uncertainty of Covid-19 on their business models, caution is still the order of the day.

Why have markets rebounded so well since the March lows?

The past few months have shown us how much disparity there can be between sectors over such a short period.

One area which is succeeding is technology, with more people embracing change amid social distancing. You only have to look at the difference between the tech-heavy Nasdaq, which has grown 26.6% year to date^, compared to just 4.9%^ for the S&P 500.

In fact, it’s just five or six large stocks that have been driving the rebound. But this is nothing new. A chart from Premier Miton shows that the five largest stocks in the S&P 500 have driven the US market for the past 25 years, returning almost 25% on average in that time, while the average stock in the index has risen by less than 10%^^.

Clearly there are factors that favour these large tech companies in the future, for example you cannot say Amazon will not be in a better place post Covid-19, as demand will grow for online distribution. But it’s not without risk as investors are paying a premium for that growth. Netflix and Snap are two strong examples of tech firms who have seen their shares rise since lockdown – however more recently they have also seen a fall since posting their Q2 results – with both indicating the sharp growth they had seen was starting to slow.

In his recent podcast, Martin Flood, co-manager of Lazard US Equity Concentrated, talked about finding tech opportunities outside the more well-known names and how dollar stores are the anti-ecommerce trade – providing services for those that cannot afford to buy online whenever they feel like it.

Trump’s top priority

What the US does have is a President who firmly places the economy as his top priority – which means there are likely to be opportunities for small and medium-sized businesses with strong balance sheets at attractive valuations – many of which have been ignored at the expense of the larger, growth driven, tech stocks.

A good option in this space is the LF Miton US Opportunities fund, managed by Nick Ford and Hugh Grieves. The 35-45 stock portfolio uses the Russell 3000 index as its hunting ground and the managers allocate a significant amount of their time to small and medium sized companies, although they will avoid start-up firms.

Another to consider is the Schroder US Mid Cap fund. The team that runs this fund invests in three types of companies: ‘steady eddies’ or less economically-sensitive companies that act as ballast in the portfolio; ‘mispriced growth’ stocks, where the team feels the market has not fully understood the firms’ earnings potential; and ‘recovery-type’ situations.

One alternative option is JPM US Equity Income, which targets an above-average income by investing in a diverse range of established stocks. Manager Clare Hart filters down the whole US market into a portfolio of 85-110 stocks.

*Source: Bank of America Securities, performance of the S&P 500
**Source: JPM, Global Equity Views 3Q 2020
***Source: The Economic Times
^Source: FE Analytics, total returns in sterling, 1 January to 24 July 2020
^^ Source: Premier Miton presentation – July 2020