P/E multiples are well over 20x and the US economy is slowing, but would advisors lose by betting against corporate America?
The US market shouldn’t really surprise us anymore when it ‘surprises to the upside.’ For years now it’s been quite consistently digesting inflation, wars, higher rates, lower rates, and a looming election with a shrug and steady upward growth. We are headed towards two consecutive years of over 20 per cent returns on the S&P 500. While investors may consider those returns something of a ‘good problem’ looking ahead we may not see such a rosy picture for US markets. Earnings growth appears to be slowing and corporate earnings are being revised down. The US economy looks set for a soft landing, but it still appears to be slowing down. In that environment, can US markets continue to deliver?
Craig Basinger, Chief Market Strategist at Purpose Investments, is weighing up the outlook for the US stock market. On the one hand he sees how expensive many large-cap US stocks have become and the facts of a slowing economy and earnings growth being revised down. He sees costs rising for businesses as they become increasingly unable to pass through inflation to the end customer. On the other hand he sees how favourable the environment is in the US for corporate earnings and knows how many levers many of these companies still have to manage a slowdown.
“Don’t bet against corporate America for managing earnings really well, but I think it’s going to become much more challenging in the next couple years as opposed to the last couple,” Basinger says. “I think we’re running into this environment where topline inflation is starting to cool and companies don’t have pricing power anymore. I think costs are gradually catching up, if they’re corporate flights or wages. I think that’s going to become the challenge for earnings going forward.”
Basinger also highlighted the relative narrowness of the US stock market — perhaps best exemplified by the so-called ‘magnificent seven.’ While some observers have likened the run of these mega-cap tech stocks to the tech bubble in the 90s, implying the likelihood of a crash, Basinger and his team believe they’re more like the so-called ‘nifty fifty’ of the 1970s. The nifty fifty run didn’t end with a bang so much as a whimper. Their growth slowed and they came to underperform the market for a sustained period. Basinger’s view is that the magnificent seven ends up in a similar dynamic of slower growth and challenging comps, rather than some dramatic crash.
While Basinger doesn’t like to engage in the game of long-term predictions, his concerns around slowing growth seem to have been echoed by a few major US banks. Recently Goldman Sachs and JP Morgan Chase offered different outlooks for the S&P 500. Goldman predicted a modest 3 per cent annual return in the coming decade while JP Morgan offered the slightly more generous prediction of 6.7 per cent annualized returns over the next 10-15 years. Both outlooks fall far below what we’ve seen more recently from US stocks.
Basinger believes that these sort of predictions tend to be proven wrong. Moreover, he notes that while high valuations are often cited in outlooks like these, high valuations have been a criticism of US markets at various stints throughout history, only for US stocks to outperform their comparatively cheaper counterparts in Europe or Asia. The US remains core to global equity markets as the largest and most diverse market on the planet, with a greater range of companies each subject to different drivers in different economic environments. Basinger also notes, though, that the risk of overconcentration in a few US names may be apparent. He currently favours an equal weight S&P 500 allocation as that may help cushion against too much concentration risk.
Moments like these, when returns have been so solid for such a sustained period, come with an almost eerie silence from clients. Advisors may be fielding less questions beyond a client asking why their more balanced allocation has underperformed the S&P 500. Looking ahead, though, Basinger sees reasons for advisors to stay committed to diversification and underline the benefits of that approach to their clients.
“We are mild underweight in US right now. But we’ve been market weight even as recently as a few weeks ago,” Basinger says. “We're not necessarily betting against America, but we certainly have to be there and want to be there because there's a lot of really long term good aspects about corporate America and US companies.”
