Personal finance

US Equity Markets Remain Attractive For Investors, Despite Inflation And Rate Hike Fears

US companies delivered a stellar performance in Q1 CY21, owing to COVID-19 vaccination drives, economic reopening and improved sentiments. And even though markets responded positively, concerns about rising inflation and its impact on the US Federal Reserve’s stance on rates have been spooking investors. The market’s steep valuations (22.7X FY2022 PE) are also making investors nervous.

However, US fundamentals are getting stronger and offer upside opportunities to investors who can stomach near-term volatility. In addition, investing in the world’s largest economy retains its key advantages of: a) geographic diversification; b) incremental return INR depreciation; and c) access to some of the biggest brands globally.

In this article, we touch upon the key trends impacting the US at this time and how investors should look at allocating funds to this market.

US outlook solid

Sector rotation

In 2020, tech, pharma and healthcare stocks had a great run as the outbreak of COVID-19 led to a shift towards growth and defensive sectors. The prevalence of low interest rates further kept valuations buoyed for growth stocks (i.e., FAANG) in particular.

However, the reopening of the economy has led to broad-based earnings growth involving cyclicals, and global reflation is working in favour of export-reliant businesses. We expect this trend to continue given the rosy economic growth outlook and potentially higher inflation, which are both key macro factors driving value and cyclical rotations.

Infrastructure push

Under the Joe Biden administration, the $1.8 trillion fiscal stimulus is likely to be released in H2 CY21. Successful implementation of capital expenditure (capex) plans has a long-term, multiplier impact on GDP, bolstering the growth prospects for several sectors. We expect interest in segments such as capital goods, materials, real estate and logistics to increase.

Tech dominance

Being the tech capital of the world, the US has a meaningful edge across established and emerging verticals such as cloud, artificial intelligence, machine learning, internet of things, 5G and robotics. Reflecting this dominance, the information technology sector’s weight has steadily increased in the S&P 500 index over the years.

Sectors such as tech tend to trade at steeper valuations than traditional economy-linked sectors. This, in turn, has helped the S&P 500 index to sustain premium multiples over long periods of time.

Bumps ahead

Inflation woes

The impact of monetary stimuli released in 2020 is reflecting in inflated asset prices. Imports have become costlier due to a weakening USD trajectory. In recent months, inflation has therefore been on the rise.

The US Fed will be forced to raise rates eventually if inflation remains persistently high, and employment numbers improve. This may lead equity markets to witness a major correction because:

-Institutional investors will start selling equities and invest in debt for better yields

-Cost of capital for businesses and borrowing expenses for consumers will move up

-An inflation build up will impact operating margins of businesses

-Future cash flows of tech stocks will be discounted at a higher rate

Fiscal deficit and tax rate hikes

With the upcoming fiscal stimulus package, fiscal (and trade) deficits will widen, thereby putting downward pressure on the US dollar.

In the medium term, any tax rate hike undertaken by the Biden administration to bridge the widening deficit, will impact earnings and consequently the markets.

Tensions with China

Lingering effects of the persistent trade war between US and China can affect US companies more than Chinese ones, especially companies that are heavily reliant on exports and imports.

Valuation and outlook

The S&P 500 is trading at a sharp upward deviation from its 15-year average, making it more expensive than other major indices as well. But what’s worth noting is that the S&P 500 has been trading above 22X PE since May 2020, a year ago. This did not impede the market’s blistering 38 percent increase, led firmly by robust earnings. This bolsters our belief that earnings, not value, will be responsible for the upward momentum of the market in the future.

In the near term, all eyes will be on the US Fed’s hints/commentary in the next FOMC meeting. We believe that the central bank may be more tolerant of inflation and stick to its dovish stance until employment improves meaningfully.

Our recommendation

The economic and earnings fundamentals for the US continue to improve, and US equities are hamstrung only by their elevated valuations at this time. For those wishing to enter the US market, we recommend a buy-on-dip strategy, while long term investors should continue their SIPs without worrying about near-term volatility. On days when sharp market corrections are seen, they can also deploy a lump-sum amount in conjunction with the ongoing SIPs.

We suggest combining an actively managed fund with a passive one. While the former possesses the flexibility to change stocks/sectors from time to time, the latter carries low expense ratios and provides benefits of steady compounding.

Disclaimer: The views and investment tips given by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises that users check with certified experts before taking any investment decision.

US outlook solid

Source: https://www.moneycontrol.com/news/business/personal-finance/us-equity-markets-remain-attractive-for-investors-despite-inflation-and-rate-hike-fears-7075031.html

Donovan Larsen

Donovan is a columnist and associate editor at the Dark News. He has written on everything from the politics to diversity issues in the workplace.

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