As global equity, including US stocks, have rallied over the past 15 months, experts are divided over how volatile and uncertain the stock market will be, and whether the US equity bubble will pop - if it is a bubble at all.
The MSCI World Index has been breaking records one after the other since April last year. Earlier this week, the index hit another record high, going over 3,050 points for the first time.
Asset owners with equity-heavy portfolios such as Japan's Government Pension Investment Fund (GPIF) and AustralianSuper have benefitted from the rally. Both have more than 50% allocated to equity and posted more than 20% returns.
US equities have also risen dramatically, with the Dow Jones Industrial Average rising above 34,000 points for the first time in April. The index closed at 34,577.37 on Wednesday (July 7).
The question now is whether US equity will continue its meteoric rise, or if some correction can be expected.
Fund managers with whom AsianInvestor spoke offered differing views but generally agreed that consumer spending is expected to drive economic recovery, and that while there might be some level of correction later this year, some sectors such as financials, healthcare and other value sectors continue to provide opportunity.
AsianInvestor asked experts for their views on whether the US equity bubble will pop and where they see the most opportunity.
The following contributions have been edited for clarity and brevity.
Kevin Anderson, head of investments, Asia Pacific
State Street Global Advisors
With quantitative easing effectively capping yields, equities remain attractive. In an encouraging turn, the trend of ballooning multiples has finally slowed as earnings growth overtook multiple expansion as the primary driver of equity performance. With earnings beginning to catch up with stock prices, we continue to overweight equities and our largest overweight is to the US large cap sector.
Our market risk indicators suggest market participants might be too complacent about the scale of economic uncertainty and potential risks, so we have pared back our overweight to global equities.
In part because the earnings gap is much wider in the US compared to other regions, where stocks are more reasonably valued, we have broadened our overweight to include European markets and may see opportunity in emerging markets appear during second half. Within emerging markets, Chinese equities call for particular focus.
Jasmine Duan, investment strategist
RBC Wealth Management – Asia
RBC Wealth Management has a constructive outlook for US equities for the coming 12 months. However, we think the market is entering a transition period - from that of a robust rally phase to a “two steps forward, one step back” phase that commonly transpires when economic recoveries come off their initial boil.
We have turned more cautious tactically in the short term. Many macro data, sentiment and valuation indicators are close to the top of their distribution range and thus the market is vulnerable to any negative news. Uncertainties about how long elevated inflation will last and how the Fed will handle it could trigger market volatility, as could investor concerns about the movement of the 10-year Treasury yield and yield curve.
We have rotated towards defensive and dividend-yielding styles and maintained a tilt towards quality factors. We see opportunities in consumer staples, healthcare and select value sectors.
Anik Sen, global head of equities
We do not believe that the US equity market is in bubble territory. The persistent rise in valuation metrics over the past several years should not be dismissed as irrational due to four main reasons. Firstly, the change in the Federal Reserve’s inflation-targeting framework should result in a longer economic expansion cycle than ever seen before under similar conditions historically.
Secondly, there is newfound confidence in the markets in the monetary and fiscal management of economic crises given the successful experience both of the pandemic and the 2008 Financial Crisis which significantly raises valuation multiples for the market. Next, investor confidence that China, as one of the main engines of global growth, has “come of age” in its macro-economic management given the successes of managing slowdowns since 2013.
And, finally, after a decade or more of uncertainties resulting in pent-up demand, the outlook is strong for capital expenditures for companies that need to invest in productivity, automation and supply chain diversification, and the US housing strength is likely to lead to a robust consumer spending. Taken together, the above four factors have resulted in higher equity valuation multiples.
Clare Hart, portfolio manager
JP Morgan US Value Fund
US equity performance has been underpinned by accelerating economic growth and rebounding profits, as the economic recovery gathered pace. A very different group of sectors drove the market higher this year, with energy and financials posting the best returns.
Equity markets are currently entering a transition phase, going from a broad-based macro rally to a more micro-focused rally, in which it is going to be about companies’ fundamentals.
The financials sector offers a lot of opportunities because of its diversity - banks, credit card companies, asset managers, and insurers – each of these different sub-sectors has different levels of risk. In the industrial space, trends in electrification and sustainability are currently creating opportunities, while the consumer space underwent an “acid test” in 2020 for business models, seeing tremendous change.
But, after a year of online shopping, we expect consumer spending to drive the economic recovery and create opportunities for rebound.
Todd Brighton, portfolio manager for the Franklin Income Fund
While multiples may look rich in many areas of the US market, there is strong earnings growth as well as reasonable valuations in several high dividend yielding sectors that we are focused on today, including healthcare, utilities and financials.
Healthcare and in particular large pharmaceutical companies like Pfizer and Merck stand to benefit as the FDA resumes reviewing drugs for approval after pausing to focus on coronavirus vaccines and therapies during the pandemic, while utility stocks should benefit from renewed economic activity and returns from recent investments in renewable power generation.
Shareholder returns from well-capitalised bank stocks like JPMorgan and Bank of America should be buffeted from a return to dividend growth and reserve releases in the coming months and years.
While the broad US equity market may correct from its recent highs, we think over the long-term there are compelling investment opportunities in specific companies currently trading at reasonable valuations.
Eric Papesh, portfolio specialist in the US Equity Division
T. Rowe Price
Although there are pockets of speculation, it’s hard to make a compelling case the broader market is in bubble territory. Over the next several months, the run-rate of corporate earnings in the US is going to eclipse anything we’ve seen previously.
The recovery won’t be a straight line, but looking out over the next year or two, it seems the runway for growth could be reasonably long, given the increases we’ve seen in consumer net worth and excess savings, combined with the fact we’re still early in the reopening process globally.
The opportunities we’ve been seeing most recently are very company-specific. We’ve taken advantage of near-term weakness to add a couple managed-care businesses we believe are well-positioned to take share and improve profitability. We’ve also added selectively within financials, where companies can drive meaningful growth in earnings, return significant amounts of capital to shareholders, and are trading at valuations well below the broader market.
David Chao, global market strategist for Apac ex-Japan
In the second half of 2021, the US is likely to lead the global economic recovery given its strong and effective vaccine rollout while the economic rebound in China moderates. The UK and Eurozone are likely to follow the US recovery, with emerging market countries lagging because of their relatively low vaccination rates, which is likely to result in periodic resurgences of Covid-19.
I think the US stock market ends the year marginally up from these levels – and I continue to think that investors will rotate from growth to cyclicals. The Fed has committed to easy monetary policy – which provides a floor for US stocks as these levels, though talk of tapering asset purchases in the next month or two may lead to some market volatility, I suggest investors to be prepared to buy on these dips.
To date, we’ve only seen the rotation to value stocks in places like Asia. It’s possible that value stock may start to outperform later on in the year in the US as growth starts to normalise.
Additional reporting by Shusi He