Opening up: A broader set of returns from the US market
The greater breadth of market performance is very evident so far in 2021 compared to last year. The returns in 2020 (shown in the light blue bars below) shows that the number of sectors that outperformed was quite narrow.
Only three of those sectors, namely consumer discretionary, communications services and technology beat the broader index performance, which is shown to the far right of the chart. And within each of these sectors, only a very narrow group of stocks drove performance – consumer technology stocks such as Amazon and Apple featuring prominently.
US sector returns show broader distribution of gains
Source: Bloomberg, with Netwealth calculations. Returns shown to 19th April 2021 in US dollars.
Past performance is not an indicator of future returns.
As you can see from the darker blue bars, the picture so far in 2021 has been quite different. It’s a universally positive picture and with the exception of energy – which has rebounded very strongly after difficulties in 2020 – there is a much narrower range of returns between sectors. The traditional characteristics of market performance have also been returning.
Therefore, healthcare, consumer staples and utilities are delivering a much more subdued performance this year and are lagging somewhat against a positive market backdrop. That makes sense – they tend to have a more muted sensitivity to market direction.
The factors which inform our positive US outlook
Now we have set the scene, we can examine the overall outlook for the US market for the coming months. Because we have initiated a positive cyclical position on the US market (believing it will do well over the short term), we should explain the factors we consider whenever we think about our cyclical positions – and how, cumulatively, these factors inform our opinions.
Macro and policy response – Positive
The macroeconomic picture for the US is positive relative to other regions. Unemployment is falling, pent-up demand for services will give economic activity a boost and the policy response from the Federal Reserve and the government is also supportive. We have easy monetary conditions and President Biden’s stimulus package has been encouraging so far and should continue to be.
The one outstanding concern on this front is how the proposed tax changes – that the Democratic government hopes to introduce – will impact the profitability of various sectors and the marginal impact of personal tax rates, too. That leads us on to the fundamentals.
Fundamentals – Positive
We think the outlook for corporate profits is positive. There was good corporate earnings performance last year and again we expect double-digit earnings growth for the year ahead and in 2022. With companies now reporting their first quarter profits, so far it’s been a very positive environment. Firms are reporting better than expected sales growth and also profitability, factors which tend to be good drivers of short-term returns for equity markets.
The weak part of the fundamentals is the level of debt that is being carried by corporate America. Because of the more challenging backdrop of the past year, companies have taken on more debt, but they were also able to reset that debt in the summer months when the corporate bond market had been calmed by the Fed’s interventions. We don’t think that the debt burden is going to be problematic for companies in the months ahead.
Valuations – Negative
The most negative aspect of the outlook for the US market, relative to other regions, is valuations and here the picture is more challenging. US equities are undoubtedly trading quite expensively versus their history and against other regions, across a number of different measures.
For instance, the cyclically adjusted price-to-earnings ratio – which is a normalised way of thinking about how expensive share prices are relative to profits – is trading at about 30 times the earnings level. That’s against a typical level of about 24 times for the US market and against 15-19 times for international comparisons.
However, this picture is clouded somewhat by the sector makeup. For example, the US has different constituents within its market versus other regions – nevertheless, the US is still a little more expensive than elsewhere.
So that dampens our longer-term expectations of what you might expect to see from the US equity market. But valuations tend to be very much a more long-term driver of returns rather than impacting over the shorter timeframe as we are considering in this instance.
Technicals – Neutral
The last part of how we think about different markets is what we call their technical profile, which are some of the more market related aspects of what is taking place within share prices – such as price trends and patterns. Here we have a neutral view on the overall situation. Previously our view was very positive because momentum within the US market had been particularly strong and that tends to have a tailwind to future performance. Also, people were relatively cautious on being invested in equities as a whole.
We have now dialled back down to a more neutral view. Although good momentum remains, a lot more market participants have been invested, so there is less cash sitting on the side-lines to propel markets higher. This means you’re more likely to see positive performance interrupted in the near term. Overall, we still think these considerations result in a fairly neutral picture.
Taking these four different factors into account – macro & policy response, fundamentals, valuations and technical – is how we have derived a positive cyclical view of the US market relative to other regions. Of course, we always consider a number of different risk factors when thinking about cyclical positions, but for now we are quite happy having a higher weight than normal allocated to US equities within the Netwealth portfolios.
Please note, the value of your investments can go down as well as up.
