This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, T. Rowe Price US equities portfolio specialist Helen Ford explains why US equity growth is slowing.
Since the global financial crisis, and despite ongoing macroeconomic and political headwinds, US equities have performed strongly from the lows seen in March 2009. This should continue in 2014, with further modest equity gains stemming from both earnings growth and P/E multiple expansion.
After a five-year bull run US equities could be vulnerable
The recovery in the US economy has so far been anaemic, which has historically been the case after a financial crisis. However, we expect the expansion to gather momentum in 2014, with GDP growth of 2.75% to 3%, compared to 2% in 2013.
Importantly, the headwinds of the last two years; fiscal tightening and the EU crisis, have abated. At the same time, underlying trends in the private sector continue to improve with unemployment continuing to decline, deleveraging at a well advanced stage and the housing market continuing to recover, while falling energy prices have positively impacted inflation.
Realistically, having enjoyed a strong rally in share prices over the last five years more moderate returns should be expected going forward. However, there are always areas of dislocation in market rallies. There are a few areas currently offering up interesting investment opportunities. With shale oil and gas production in the US rising rapidly, companies benefitting from lower energy prices such as aerospace and chemical manufacturers could perform well. In addition, the shift to mobile devices and internet retailing potentially offer ways to play the rise in emerging market consumers’ incomes, at a time when large multinational consumer stocks appear fully valued.
Since the recession, US corporations have aggressively cut costs and boosted productivity. Companies have also benefited from lower energy prices, which in turn is leading to a renaissance within the manufacturing industry. These factors combined with moderate wage growth have all helped to push profit margins to historically high levels. However, it is difficult to see profit margins rising much further from here.
Balance sheets generally remain strong, with high levels of cash. So far, managements have avoided potentially value-destroying acquisitions and instead have focused on returning capital to shareholders through share buybacks and increased dividends. However, we are likely to see an increase in M&A activity and capital spending. This could potentially be one of the main pivots for the market in 2014.
Taking all this into consideration we are moderating our positive view on US equities. To use an analogy, moving our outlook from green for go, to flashing amber for caution. There do remain many tailwinds. US Economic growth is set to improve in 2014 and investor sentiment continues to be more positive.
Unemployment continues to decline, the housing market continues to recover and falling energy prices are positively impacting inflation. Stock valuations are now at or above long-term averages and the risk-reward is more balanced. After a five-year bull run – the average period for bull market rallies – US equities could be vulnerable to a meaningful correction, although it may be very possible the cyclical bull market may have further to run. For this to happen though, increased revenue growth is needed to sustain market momentum.
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