US equities set to endure volatile year

The co-manager of the Legg Mason Clearbridge US Aggressive Growth fund said given the huge rise in the US equity market since the depths of the financial crisis, gains would be harder to come by and valuations in more areas of the market would be stretched.

The fund’s benchmark, the Russell 3000 Growth index, has risen 236.1 per cent in dollar terms since March 2009, outpacing the 213 per cent increase in the S&P 500 index and greatly outstripping the 165 per cent rise in the MSCI AC World index, data from FE Analytics shows.

“The current bull market entered its seventh year in the [first] quarter and we expect a tougher period for equities at this advanced stage of the cycle,” Mr Bauman said.

“Valuations in some parts of the market are expensive, while the reality that the Federal Reserve will raise the interest rate at some point this year has created more volatility on a day-to-day basis.

“Liquidity is also a concern, with capital moving from sector to sector rather than new money coming into the stockmarket.”

The manager said merger and acquisition activity had also spiked recently, driven in part by the growing likelihood of a rise in the US interest rate.

“We believe the anticipation of higher rates in the future is spurring companies to engage in capital market transactions before financing costs rise,” Mr Bauman said.

“Companies are [increasing] merger and acquisition activity, especially in the healthcare sector where we saw portfolio holding UnitedHealth Group announce its largest-ever acquisition of pharmacy benefits manager Catamaran late in the quarter.”

He said global pharmaceutical company Actavis, another holding that had been an active acquirer of biopharmaceutical companies, completed a $21bn (£14.2bn) bond offering “at attractive terms” to finance its announced purchase of Allergan. He added this deal was the second largest on record.

Analysing the fund’s first-quarter performance, Mr Bauman said four of the seven sectors it invests in from a possible 10 in the benchmark produced positive absolute returns.

Healthcare and discretionary plays were the best performers, he noted.

“The leading detractor from absolute performance was the information technology sector,” he said.

“The strategy had no holdings in the consumer staples, utilities or telecommunication services sectors.”

The manager acknowledged stock selection had a “negative impact” on performance for the period, while sector allocation was positive.

“In particular, stock selection in the IT sector was the primary detractor from performance, while selection in the energy and consumer discretionary sectors also had negative impacts,” he said.

“Stock selection in the healthcare sector and an overweight to healthcare, which was the best-performing sector in the index, had significant positive impacts on performance.”

Mr Bauman added the strategy ended the first quarter with about 10 per cent of its assets in cash, which he said was “a reflection of strong and steady inflows that have been greater than our buying activity”.

“We continue to put this cash to work by dollar-cost-averaging into existing positions when volatility creates attractive valuations,” he said.