Euphoric valuations and continued uncertainty over the direction of governmental policy have raised further questions over US equities’ ability to avoid a sharp pullback.
Following years of impressive returns, the two major US indices have returned a further 21 and 27 per cent over the past 12 months, almost a third of which has occurred in 2017.
The S&P 500’s trailing price- to-earnings (p/e) ratio is now over 25 times, as investors pile into stocks in expectation of the corporate tax cuts touted by president Donald Trump.
But concerns are growing over whether the policy changes on which the latest rally appears to be based will materialise. Mr Trump gave his maiden speech to Congress last week but a lack of detail disappointed investors. Meanwhile the US Federal Reserve has showed signs of a more hawkish stance. Speeches given by board members on the same day as Mr Trump’s address sent the chances of a rate rise in March rocketing to 80 per cent.
JPMorgan Asset Management global market strategist David Stubbs said another stockmarket metric, enterprise value to ebitda – a measure that takes into account company debt – was at a level corresponding to previous market peaks.
“You can understand why people say [the time to reallocate elsewhere] is right here.
“Mr Trump has promised everything to everyone and that expectation is now in the price. When you have valuations that are fairly rich you are vulnerable to disappointment. You need everything you think is going to pan out, to pan out. That’s not the way things go.”
Ian Heslop, manager of the £1.9bn Old Mutual North American Equity fund, admitted the chance of policy disappointment was growing.
“The likelihood of Trump delivering to a level to appease what has already been built into markets should be a concern,” he said.
Mr Trump’s plans include a personal tax cut, corporate tax cuts targeted at smaller businesses, fiscal stimulus and a broader plan of deregulation. Conversely, there are worries over the proposed “border adjustment tax”, which could prove negative for importers.
Some investors have repeated the common refrain that corporate earnings must improve if current price levels are to be maintained.
“We need earnings upgrades to come through and justify these valuations,” said Nick Peters, multi-asset portfolio manager at Fidelity. The manager has reduced US equity exposure in his funds and described himself as now being in “wait and see” mode.
Several managers cited the positive fundamentals for US stocks, regardless of politics.
Cormac Weldon, manager of the £562m Artemis US Select fund, said: “If [the corporate tax cut] doesn’t happen the market will pull back, that’s no question. [But] we don’t believe the Republicans will finish this year without [it].”
He said the key question for US equity valuations was whether Mr Trump succeeded in elongating the US economic cycle. If so, Mr Weldon predicted the average forward p/e ratio would eventually fall from 18.5 to around 15 times, even under a conservative estimate.
Mr Stubbs noted the political shadow over Europe meant investors were reluctant to reallocate away from the US.
“Something will come from the Trump administration…to support some earnings growth, and as long as they trend higher, valuations will trend higher. It is tough to say the US will not remain in some kind of bull market.”
