Hanging tough!

US equity investors have experienced (enjoyed?) an exhilarating roller-coaster ride over the past twelve months. Having rallied strongly throughout 2017, US equities hit an early 2018 brick wall - falling some 8%.

But, dazed investors quickly recovered as President Trump’s tax cuts rode to the rescue; profit forecasts surged. “Onwards! Upwards!” was the rallying cry.

This renewed confidence was destined not to last. Approaching the final quarter, investors grew increasingly skittish about the potential fall-out of a possible trade war with China, the implications for world growth of a slower growing Chinese economy and perhaps, most significantly, fears of a tighter US monetary policy, as US growth remained strong with subdued inflationary pressures. Equities slumped over 15% during the final quarter of 2018¹.

An unexpected development broke the investor malaise in early 2019; the US Federal Reserve performed a backward somersault on interest rates. Rates would not rise as fast as feared. Sufficient liquidity would exist to support the financial markets. The Fed “Put” was back. Not unexpectedly, US equites once again rallied.

Following 2019’s early bounce-back, many investors are now asking, “Is this the start of the next rally or is it a ‘dead cat bounce’ in an extended sell-off?”

This is clearly a critical question for us as investors. There are compelling reasons for arguing that we are at the start of the next leg of a rally (not only in the US but also in select emerging markets).

Equity valuations², for example, are significantly more supportive than they were a year ago when investor fervour (boosted by the tax cuts and IT mania) had dragged them into what many would regard as expensive territory (Fig 1).

Fig 1: US equity valuations fall back into attractive territory³

While equities are not as cheap as they were at early January’s lows, the market valuation remains comfortably within the “Fair-value” range. The technology sector is again flirting with “Fair” value, and looks far better value based on the prospective price to earnings ratio alone. Bank valuations have slumped and are again not only bouncing along their historical lows but also are just shy of “Very Attractive” valuations.

It is difficult to escape the conclusion that US equities look good value especially as the fundamental outlook seems solid. For example:

While the case for US equities remains strong, we are not out of the woods yet. Trade war, China growth and liquidity uncertainties still lurk waiting to catch the unwary off-guard. Some analysts continue to shave their profit growth forecasts.

So, the roller-coaster rise is not over, it seems. But, given the still promising outlook, we’re hanging tough.

We remain overweight US equities.