Our US research trip has been a long time coming, two and a half years to be exact, delayed to due various lockdowns and Covid measures. After finally arriving, it was an apt time to make the journey, given the unusually weak performance of US equities versus major markets at the beginning of the year. We’d seen stock market darlings of recent years’ experience significant drawdowns as investors reassessed whether strong earnings growth was genuinely here to stay, or how much rising interest rates would impact the multiples they were willing to pay for those cash flows.
On US soil, we met with fourteen fund managers, fourteen analysts, two strategists and a CEO, across seven funds and three interesting new ideas. It was clear that for many we were their first in-person meeting for a long time.
Soft landing
The main observation from our trip was that the focus for US managers was not the war in Ukraine, as it is likely that the domestic economy is relatively well isolated, but the rise in inflation. Both energy and wage inflation were already increasing even before the conflict in Ukraine and managers are looking to how the Federal Reserve will react to its highest inflation prints in forty years. Following on from the policy meeting, financial markets in the US have remained focused on the potential for more aggressive interest rate hikes from the Fed. Chair, Jay Powell, has continued with the hawkish messaging that accompanied the interest rate hike and expressed confidence that the Fed can continue to tighten policy without leading the US economy into recession.
The main observation from our trip was that the focus for US managers was not the war in Ukraine, but the rise in inflation.
We expect a lot of talk over the coming months of the potential for a ‘soft landing’ versus a recession. History shows engineering a ‘soft landing’ is not simple and even if the US escapes a recession, tighter monetary policy in the US usually causes trouble somewhere. The last ‘soft landing’ of a hiking cycle without a US recession was in 1994 but this still saw a huge crisis in Mexico and Latin American bonds and sowed the seeds for the 1997 Asian financial crisis. Even if the US does ultimately get monetary policy just right to not tip the US into recession, it does not mean that we will not see consequences elsewhere.
Lockdowns pushed tech growth further in the US
The US market has performed fantastically well since the Covid lows. Since our previous trip to the States two years ago, US equities have continued to be the strongest major market. It has been focused on higher ‘growth’ names and those that were seen as a beneficiary of lockdowns – with the likes of Amazon, Microsoft and the general increase in the use of technology as the world switched to virtual. These stocks were already a large weight in the US index, so helped power the majority of US indices to fresh and record highs.
Since our previous trip to the States two years ago, US equities have continued to be the strongest major market.
Last year, this trend broadly continued, the list of names driving the market narrowed but this did not stop the performance of the index. The S&P 500 hit all-time highs but US equity gains were concentrated in just a handful. The market was up 24%, yet just five stocks accounted for half of that gain (Apple, Microsoft, Nvidia, Tesla and Alphabet), despite comprising only 18%of market capitalisation at the beginning of the year.
Value biased managers more upbeat
The value biased managers came across more upbeat on the shorter-term outlook in our meetings. Value investing has historically performed well in inflationary environments. Despite the pickup in value funds performance, money flow is still positive for underperforming growth managers. More recently, we have seen a change in leadership of the market and concern from the Fed about inflation has resulted in higher growth higher valuation names selling off and the value sectors (energy and financials) start to perform better. This has resulted in a change in fund performance and rankings, with the previous value managers that had been facing headwinds now shooting up in the charts with a strong tailwind, while well owned growth favourites are facing some more challenging times. Growth managers believe that if growth (GDP) does slow, their portfolios should hold up well as investors will continue to pay a premium for structural growth (i.e. Technology sector).
Despite the pickup in value funds performance, money flow is still positive for underperforming growth managers.
We remain neutral in our view on US equities for now, cognisant of elevated multiples but recognising that many US companies are global leaders and highly profitable. Seeing some of the froth come out of speculative areas of the market, however, is certainly welcome and should provide an opportunity for managers who are genuinely active.
Scott Spencer is investment manager in the multi-manager people team at BMO Global Asset Management (EMEA)
Comments