It is rare to see the market totally lack consensus, as it did in the aftermath of Standard & Poor’s decision to downgrade US downgrade to AA+ from AAA in August. While the severity of the structural problems in global markets is undisputed, corporate America is thriving and stockmarkets are enjoying a number of positive tailwinds, confusing the picture.
US stocks fell 10 per cent in the week following the downgrade, leaving the S&P 500 trading at around 12 earnings, a rich hunting ground for active stock pickers, who pointed out that these were the same stocks that in 2000 sold for more than 30 times earnings.
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| Table: US Equities Funds (CLICK TO VIEW) |
RATES REMAIN LOW
Plummeting prices also meant the dividend yield on many stocks was similar to government bond yields, such as the 2.5 per cent paid on benchmark 10-year Treasuries. Comparisons will continue to look attractive as interest rates are now expected to stay at rock-bottom for some time.
Moreover, corporate profits reached record highs in the second quarter, historically often a first step toward a durable economic recovery. Companies flush with cash have been boosting their dividends and many are now looking to grow their businesses by merger and acquisition. Bear markets rarely take root when corporate earnings are healthy and interest rates low. There are also other ad hoc tailwinds, such as the Japanese disaster, which slowed economic growth in the second quarter, but will create a rebuilding bonanza in the rest of 2011.
However, plenty of disappointing data points to slower US growth while the deleveraging process runs its course. Although the US economy has expanded for eight consecutive quarters, growth in the past two quarters has been feeble. Confidence in the US manufacturing sector has also dipped below expectations, according to the Institute of Sales Management survey of manufacturing confidence, which is generally a good predictor of markets. While employment data has been broadly in line with expectations, the 117,000 new jobs created in June marked progress of only meagre proportion.
“Our view, at least for the time being, is that we are facing an economic slowdown, but not a recession, and the economic environment will proceed at an extremely low rate of growth,” says Habib Nasrallah, senior product specialist for core equity funds at Pictet.
“The US corporate sector is in its best shape, having already downsized its labour force, and inventory levels are lean. Moreover the contribution of the housing market to GDP has fallen from 7 per cent to 3 per cent, so the continuous house price decline won't have the scale of impact it had three years ago. We don’t have the ingredients for another recession.”
For the brave, there are plenty of opportunities in equity markets. “The S&P 500 index is trading at just under 12 times – historically that level has been very attractive,” says Mark Stoeckle, CIO, US and global sector equities at BNP Paribas Investment Partners.
“A lot of air has been taken out of the markets so there are some pretty attractive valuations. Over the last four years, US companies have shown an amazing ability to generate top-line growth and EPS (earnings per share) growth in very difficult and uncertain times. The second quarter earnings season has been good with each sector exceeding EPS estimates,” he explains.
“Companies have been able to deliver this growth because they are lean, and the consumer has been amazingly resilient throughout this whole process,” adds Mr Stoeckle.
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“I’d say there is a bifurcation between the low end which has been limping along and the mid and particularly high end which have been doing remarkably well,” he explains. “And the fall in energy prices in the last few months have been almost a direct rebate to the low end consumer, and a tailwind for all consumers.”
Most active managers in this space are focusing on large cap quality stocks, preferably dividend-payers, with strong balance sheets and dominant positions in their markets, whom they believe will still be able to increase their top-line growth in a morose environment. Megacap stocks have underperformed for some time, and as investors look for safety, these types of stocks are attractive.
“While we’re aware that public sector stimulus is fading fast, we do see the economy as having a mid-cycle correction rather than a reversal,” says Jonathan Price, client portfolio manager for US equity at JP Morgan Asset Management. “Corporate America is still in good shape.”
He thinks there are strong opportunities in the media and tech sectors. “In traditional media, the risk from the internet challenge is overdone and the ability to grow advertising revenue is underappreciated,” says Mr Price. “In tech, there is a move to greater mobility and to cloud computing, and US companies are well placed to play that secular shift. There has been some component supply side disruption from the Japanese disaster but long term fundamentals are strong.”
Several fund managers cite Cisco and Apple to demonstrate that even the largest tech stocks are now cheap.
