US stocks are no longer cheap – but there are reasons for the market rally to continue over the next 12 months, according to JP Morgan.
Donald Trump’s presidential election victory caused a minor blip in markets in November – but one day later the S&P 500 resumed its climb, continuing its near eight-year rally. The price to earnings ratio of the US now is at 17.7x against a 26-year average of 15.7x for the S&P 500. Many investors are using this figure to conclude that the market is overpriced and due a correction.
Every new market across the pond raises speculation on how long this rally will last and when the best time to take profits is after such a considerable bull market. But according to David Stubbs, global market strategist at JP Morgan Asset Management, there are reasons for investors to stay invested.
“We believe that corporate earnings in the US will continue to rise, and this will continue to support the US stock market rally, despite valuations not being cheap,” said Stubbs.
No Sign of Recession in the US
Nandini Ramakrishnan, also a global market strategist with JP Morgan agreed, saying that historically the growth of corporate profits was a key indicator to ascertain whether an economic slowdown or recession was on its way.
“When corporate profits start shrinking, people lose their jobs and businesses start to scale back their investments. That’s why tracking profit lines has been important to us. Profits are always the first to fall before recession,” Ramakrishnan explained.
Ramakrishnan admitted that corporate earnings in the US did weaken a year ago, which raised questions whether a recession was on its way.
She compared last year’s market to the period between 1986 and 1988, when there were also a short-term fall in corporate profits coupled with a fall in the price of oil and a strong US dollar. There was no recession after the year of 1988, and Ramakrishnan believes the same is true today.
“Profits have recovered significantly, going into positive growth territory now,” Ramakrishnan added.
Her colleague Mike Bell added: “Prematurely giving up on the bull market could be costly in terms of lost upside potential. History teaches us that the performance of shares in the last leg of a bull market tends to be strong.”
Another tailwind for US equities is the manufacturing level in the US – as correlation between S&P 500’s earnings and manufacturing data is very high. Other relative indicators; data that tracks initial jobless claims, consumer confidence, housing starts and Conference Board Leading Economic Index, are not seeing weakness either.
Prepare for Volatility
However, this momentum does not mean US equities do not have the potential to disappoint, Stubbs added.
“The market could absolutely trade sideways for a quarter or two. But fundamentally we know that equity bull markets are driven by earnings trending higher, and we do think that is going to continue, not just from this year but into next,” said Stubbs.
Top Performing US Equity Funds
Using the Morningstar Fund Screener, we looked at top rated US equity funds which are the best performing in their sector year to date. They are one Bronze Rated fund, one Silver Rated fund and one Gold Rated fund, all up more than 5% to date.
Brown Advisory US Equity Growth is a Bronze Rated fund by Morningstar analysts. The fund remains a worthy option for investors seeking exposure to the US equity market, said Fatima Khizou, Morningstar’s fund analyst. From its launch in November 2009 through the end of February 2017, the fund has outperformed its US large-growth equity Morningstar Category peer by 1.2% on average each year but lagged the Russell 1000 Growth Index by 2.2%, said Khizou. The fund gains 8% year to date.
Heptagon Yacktman US Equity is a Silver Rated fund by Morningstar analysts. Khizou believes this fund is a viable option to gain exposure to US equities, but investors here need to be patient and prepared to endure extended periods of relative weakness. The fund manager Donald Yacktman prefers companies with predictable, recurring revenue streams. This leads to a portfolio biased to relatively steady, strong franchise brands, particularly consumer names, which have typically accounted for more than 50% of the overall portfolio’s assets at any point in time, said Khizou. The fund gains 5% year to date.
Vanguard US Equity Index is a Gold Rated fund by Morningstar analysts. This index-tracker provides a very low-cost, one-stop solution to gain access to US equities, said Monika Dutt, Morningstar’s passive analyst.
The fund uses optimised replication – investing in the majority of index constituents – to track the S&P Total Market Index, said Dutt. The index captures about 99% of the US equity market and as such includes mid-, small-, and micro-cap stocks, making this fund more susceptible to the effects of local economic changes, Dutt added.
