The outlook for US equities

Having been the poster child of global stock markets for the past decade, the US stock market has had a shocking 2022 so far. April was only the fourth month in nearly 50 years that the S&P 500 fell more than 5%*. What’s more, US treasuries simultaneously fell around 2%*.

“For US equities it marked the worst 4-month start of year period since 1939 (and third worst on record), while for US 10-year bonds it was the worst total return since 1788, just before George Washington’s presidency,” said Hugh Sergeant, manager of ES R&M UK Recovery fund.

The situation has not improved, and, in June, headline inflation topped 8%, while the US stock market entered bear market territory, having fallen more than 20% from its peak.

Our Elite Rated and Radar US equity funds have not been immune to the fall out, although some have held up better than others.

JPM US Equity Income, for example, has fallen just 1.62% year to date, while the growth-orientated Baillie Gifford American – the best performing fund of 2019 and 2020 – has seen its value more than halve.

Elite Rated US equity fund performance year to date

FundPercentage returns year to date*
JPM US Equity Income-1.62%
Schroder US Mid Cap-10.32%
Artemis US Extended Alpha-12.03%
Premier Miton US Opportunities-12.65%
Brown Advisory US Flexible Equity-15.16%
T. Rowe Price US Smaller Companies Equity-16.47%
AXA Framlington American Growth-20.35%
Artemis US Smaller Companies-24.15%
T. Rowe Price US Large Cap Growth Equity-25.93%
Premier Miton US Smaller Companies-27.57%
FTF Martin Currie US Unconstrained-29.11%
Baillie Gifford American-51.06%

So, should investors cut their losses in the world’s largest economy, or is now the time to buy?

Bob Kaynor, manager of Schroder US Mid Cap fund, says that whereas the S&P 500 has delivered the best returns in recent years, driven by a small number of companies, there is a strong case for diversifying US equity exposure more into small and mid-caps looking ahead. “They offer better earnings growth than large caps at some of the largest valuation discounts in history,” he said.

However, James Yardley, FundCalibre’s senior research analyst prefers US large caps at the moment. “I’m expecting a recession in the US,” he said. “The high price of petrol and inflation is starting to really depress US consumer sentiment. This will hit the domestic economy and be more negative for US small caps.

“I prefer the cash generative growth mega caps which are starting to look quite cheap. That said, we still really like US small caps for the long term.”

Are US government bonds a better bet?

With yields now at 3%, US 10-year treasuries are looking more attractive.

“On the one hand, the US 10-year is a dream asset in the portfolio as it has a negative correlation to equities at times of extreme stress,” said James Yardley. “But with inflation over 8% and yields at 3%, that is a huge differential.

“If you are buying 10-year treasuries today you have to believe that inflation is going to come down significantly, or you risk further losses. Do steep Fed rate rises kill growth and inflation and send us into recession in which case 10-year yields are likely to fall heavily as the Fed reverses course? Or does the combination of quantitative tightening, a tight labour market, higher rates and inflation send US 10-year yields soaring north of 5%? I’m in the camp that starts to build the US ten-year and reduces high yield exposure in case of recession.”

Mark Holman, a portfolio manager at TwentyFour Asset Management, is of a similar mind. “The world’s favourite safe haven asset looks to suddenly be back in fashion, and that is because for some, recession is now looking more likely and less far away than it did a few weeks ago.

“We think building a position in 10-year US treasuries is now a serious consideration for bondholders, as is gradually increasing credit quality and focusing on shorter dated bonds in the coming months in order to try to get maximum benefit from the higher yields on offer in fixed income today.”

TwentyFour Corporate Bond, TwentyFour Dynamic Bond and TwentyFour Absolute Return Credit are all Elite Rated by FundCalibre.

Hold fire until interest rates stop

“When the rate hikes stop, and investors can once again value risk with some certainty, cheaper asset prices across credit and sovereign bond markets alike will represent an incredible opportunity set for investors seeking attractive returns,” said Dickie Hodges, manager of Nomura Global Dynamic Bond fund. “The opportunity is coming, and we are ready to pounce on it. We just need to remain patient for now. But 2023 and 2024 could be good for fixed income markets.”

Maneesh Bajaj, manager of Brown Advisory US Flexible Equity, agrees: “Due to unprecedented inflation, Ukraine war and the aftershocks of the pandemic, investors across various financial instruments (stocks and bonds) are more skittish today, driving up the risk premiums.

“It is difficult to gauge where the long-term interest rates will finally settle, which will be the ultimate arbiter of equity valuations and returns. But despite the uncertainty, our view remains that over the longer-term, U.S. equity markets are the right bet for capital appreciation.”

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.