- The US is much stronger in terms of innovation and companies that are dramatically changing industries have driven some of the stock market gains
- US strengths that other regions lack include well-contained inflation, positive economic growth, innovation; and a robust banking system
- The major long-term challenge facing the US is the budget deficit. The Democrats are reluctant to address an issue that the Republicans are at least discussing.
Cormac Weldon, Head of US Equities at Threadneedle, addresses some of the questions currently on the minds of US equity investors. Overall, he believes that US stocks remain attractively valued and that some sectors offer particular value. Cormac also points out the positive aspect of the political division in Congress over the budget deficit and the debt ceiling.
US stock markets are higher now than before the 2008 financial crisis. How is that possible?
Earnings have recovered and surpassed their previous peak so therefore it is entirely understandable that the market should have performed so well.
European stocks have yet to regain their previous highs. Why has the US performed so much better?
The reason that US earnings have recovered is that America quickly implemented dramatic steps to stabilize the economy in 2008 and 2009. Measures included forcing the banks to accept fresh capital and to raise equity and capital levels. As a result, US banks are well capitalized and loan growth is positive. By contrast, European banks remain poorly capitalized and lending growth is negative on the Continent.
Moreover, the US is much stronger in terms of innovation and companies that are dramatically changing industries have driven some of the stock market gains. Examples include Google and Facebook and other internet companies that are changing how companies advertise and gaining market share through innovation.
What do you think of the current level of valuations in the US? Are stocks still attractive?
We believe that the market remains fairly valued and is certainly not overvalued in historical terms although neither is it cheap. However, when compared with other asset classes such as bonds, stocks do look attractive.
How do US valuations compare to other regions?
The US is clearly more expensive than other regions but we believe this simply reflects strengths that other regions lack including: well-contained inflation; positive economic growth; innovation; and a robust banking system.
Many experts have increased their allocation in US equities. Is that a good move?
It certainly has been in terms of performance over the year to date and we believe it will probably remain prudent to have a good allocation to US equities, particularly given that the Federal Reserve is targeting employment levels, which means that is also focusing upon economic growth. Given that inflation remains low, this is almost certainly a very good environment for equities to continue to perform well.
Does the debt ceiling issue pose a serious threat to the economy?
Although the political shenanigans in Washington generate many headlines, we believe they are very much a secondary issue in terms of their impact upon markets and the economy. While there may be some negative effects, we believe that these will be more than offset by the Federal Reserve’s willingness to prolong quantitative easing.
Moreover, we would rather see political bickering than a situation where the Democrats controlled Congress and were able to do as they pleased. This is because the major long-term challenge facing the US is the budget deficit, particularly given that healthcare expenditure will explode in 10 years or so. It is very clear to us that the Democrats are reluctant to address an issue that the Republicans are at least discussing. Thus, we would prefer to see some political turbulence over the budget deficit than a government able to ignore it entirely.
What do you think about the appointment of Janet Yellen to head the Federal Reserve?
We can only comment upon what we have read about her. She is clearly experienced and we are impressed by the fact that her economic forecasts have been more accurate than other policymakers within the Federal Reserve. This record appears a very positive factor.
What are your expectations for the coming months and for 2014?
We believe the market will make further gains. It tends to at this time of the year while all should be quiet on the political stage for a while. Whilst the economy is growing moderately, the Federal Reserve continues to stimulate the economy by buying treasuries and maintaining interest rates at very low levels.
Can you give examples of two companies in your top 10 holdings and explain why these stocks are interesting?
We like Google, where revenues and earnings are growing at healthy double-digit rates – with earnings probably expanding at 20% plus per annum. This has been the case for a number of years and we anticipate this pace will continue given that it is changing the face of the global advertising industry. Although it trades at 19 times next year’s earnings, it is important to remember that earnings will double over the next four years if it maintains a 20% earnings growth rate.
Charter Communications is another favored stock. The cable business had been poorly managed but under a new chief executive, who took over two years ago, has benefited from hefty investment. Consumers are buying more services, such as digital movies and broadband internet, from the company and are paying higher prices for them. Consequently, we believe the company will enjoy good growth in the coming years. Moreover, it is possible that Charter will be involved in any further consolidation within the US cable industry.
Cormac Weldon is Head of North American equities at Threadneedle. He began his career with KPMG in Dublin in 1987 before moving to Provident Mutual in 1991 to take up the role of analyst on their North American equity team. He then joined British Gas Pension Fund in 1993 as a portfolio manager in charge of North American equities. He holds a BA in Accounting and Finance from Dublin City University, is an Associate of the Society of Investment Professionals (UKSIP) and a CFA charterholder