US markets surging on back of strong corporate profits

By comparison, the FTSE All-Share index has risen only 15.33 per cent in 2013 to September 27, according to FE Analytics.

Ed Cowart and John Pandtle, co-managers of the Nordea 1 North American All Cap fund, explain: “The US Equity market is trading near historical highs, but it is important to remember that an impressive surge in US corporate profits has been a key driver of the stockmarket’s four-year advance.”

David Daglio, portfolio manager and senior managing director at The Boston Company Asset Management, a BNY Mellon Subsidiary, agrees that now is an exciting time for US equity investors.

“Over the past 50 years, there have been 12 instances of ‘bear steepening’ in the US Treasury market in the run-up to Fed tightening and during which investors lost money. The average return of the US equity market in the following 12 months was 9.7 per cent,” he says.

“In two instances returns were negative, for example, in the late 1980s, but this was caused by inflationary pressures; the latest inflation numbers in the US show zero evidence of inflationary worries.”

Mr Daglio adds that the US is coming to the end of a three-decade long bull market and therefore now is a “great moment” for fundamental equity investors.

But given the market’s strong gains so far in 2013, should investors be concerned that valuations have reached their limit and they have missed the boat? T.Rowe Price’s portfolio specialist Helen Ford does not think so.

“While the forward price/earnings ratios of the main market have expanded after many years of compression they remain relatively close to their 15-year average. Although bond yields have also risen, the spread between the earnings yield on stocks and the yield on the 10-year Treasury note still makes stocks look attractive relative to debt securities,” she says.

“With growth being a critical input of valuation work, it is crucial [for investors] to scrutinise firms at the fundamental level and identify candidates that offer the most compelling risk/reward profile.”

Ms Ford warns that it is unlikely that investors will see a sharp uptick in growth in coming quarters, and therefore should be focusing on companies that can “demonstrate robust recurring revenues, free cashflows, and returns on equity”.

She adds: “The debate now centres on the outlook for earnings and whether companies can sustain margins and continue to grow revenues.”

There may be trouble ahead

There are, however, a number of headwinds that could pose a risk to those with exposure to US equities, most notably the continuing pressures facing the eurozone and the ongoing fiscal policy debates in Washington.

“It would be rash to ignore the various headwinds challenging the US equity markets,” Ms Ford warns. “The eurozone remains a risk factor although recent economic data points to some very modest improvement. China’s future growth rate also remains unclear as it transitions to a consumer-driven economy.

“Also, gridlock in Washington over the direction of fiscal policy raises concerns given the extremely low levels of trust between Republicans and president Obama.”

But Mr Cowart and Mr Pandtle believe the US corporate sector to remain a bright spot in an otherwise lacklustre global economic environment.

“Much of Europe is struggling with austerity and recession, while Japan is trying to finally get monetary policy right after 20 years of failing,” they say.

“Additionally, China is attempting the difficult transition from an investment-led to a consumer-led economy and other emerging markets are experiencing all manner of growing pains.

“Meanwhile, the US corporate sector is recording all time highs in earnings, cashflow and cash on balance sheets. The trajectory of corporate profit growth may slow over the next few quarters, but we believe equity markets have already discounted this short to mid-term risk.”

There is now doubt that opportunities for investors in the US equity market remain, the difficulty going forwards will be identifying those that will offer the best combination of growth and income.