US equities: cut your losses or invest more money?, July 2022

Both US equity and bond markets have 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% and 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.

So, should investors cut their losses in the world’s largest economy, or is now the time to buy? We gathered the views of some US equity fund managers

Will the US economy start to slow?

Justin Streeter, US equity manager at Comgest, said: “The US economy is strong, some would say overheating. Unemployment is close to record lows, consumer savings are elevated and there are positive signals in corporate earnings. The flip side is elevated inflation, supply chain constraints, and staffing difficulties. The Federal Reserve raised interest rates to cool inflation by three-quarters of a percentage point on 15 June, which will also make financing more difficult.”

Cormac Weldon, manager of Artemis US Smaller Companies fund, says there is a tug of war going on between the economy and the Federal Reserve (US central bank). “In the short-term there is strength in the economy. We have a high savings rate among the upper 60% of income earners, and the Bank of America recently announced that those people who had $1,000 in their accounts pre pandemic have $7,000 today.

“Spending is higher than it was in 2019 and pent-up demand is now skewed towards services, with consumers enjoying their first holidays or visiting family post-pandemic. But at the same time, it appears we’ll get a slowdown in consumer demand going forward – high energy and food prices are starting to take their toll.”

Bob Kaynor, manager of Schroder US Mid Cap fund, added: “US companies are currently functioning in an environment that few managers have witnessed before. Generally, there is strong demand, but an unfortunate bedfellow is high-cost inflation. Recent events have enhanced the strengths of the US economy. Most importantly, the US has enough energy to not only provide for the country but increasingly, once the infrastructure is built, to export to Europe – replacing Russian energy reliance.” 

What does this mean for the stock market?

Martin Flood, manager of Lazard US Equity Concentrated, said: “Anxiety about rising inflation continues to hang over markets and has grown worse after the US and its Western allies imposed harsh retaliatory economic sanctions on Russia in response to its invasion of Ukraine. 

“We expect that, as investors come to terms with the changing market environment and the challenge of predicting its trajectory, they will instead increase focus on company fundamentals.”

Bob Kaynor continued: “The debate on how much economic news is already discounted in the market persists. There are certain areas of the market, including some cyclical stocks, that are trading at trough valuations and yet have continued to see positive earnings revisions. How these sectors behave when earnings begin to rebase will be a good indication of what is priced in.

“In general, we are more favourably disposed to a commercial spending cycle in which budgets have been approved, money must get spent or lost and the reaction time to a changing economic environment tends to be slower. This can also include infrastructure, municipal spending, and commercial construction. 

“Additionally, our conversations with companies indicate easing pressures on labour and certain components of the supply chain. Based on these insights, we are targeting companies with revenues that are not overly sensitive to the economic backdrop, where the cost pressures of labour and transportation have been holding back margins. 

“Looking ahead, the consumer is in for a shock and is likely to sharply pull back on spending. However, companies are already committing to long-term capital expenditure, which is our focus. This comes down to Industrials vs. Consumer.”

Are large caps or small caps better value?

Maintaining US equity exposure is important, because it is, after all, the largest economy and stock market in the world. But 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, according to Bob Kaynor.

“Small and mid-caps are much more exposed to the US economy,” he said. “They offer better earnings growth than large caps at some of the largest valuation discounts in history.

“US small and mid-cap stocks also tend to source their revenues more domestically, insulating them somewhat from global geopolitical disruptions. In my view, cheaper valuations and faster earnings growth offer a better entry point relative to US large caps.”

Justin Streeter says that in this environment, it helps to be an all-weather franchise. “Quality growth companies are usually resilient, high-visibility businesses with proven profitability and strong balance sheets,” he said. “A number of these companies aim to enhance clients’ productivity, pass along efficiency gains and help cut costs even as inflation rises.”

Maneesh Bajaj, manager of Brown Advisory US Flexible Equity, concluded: “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.”

The six US equity funds on the Chelsea Selection are: AXA Framlington American Growth, Baillie Gifford American, Brown Advisory US Flexible Equity, Fidelity US Index, FTF Martin Currie US Unconstrained and Premier Miton US Opportunities. 

*Source: River & Mercantile, May 2022

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the fund managers and do not constitute financial advice.