Where next for the US market?

The US market has attracted criticism – it is too expensive, growth is slowing and companies may have hit peak earnings – yet it still holds considerable opportunity for the careful stock picker, says Tony DeSpirito, Co-Portfolio Manager of the BlackRock Sustainable American Income Trust plc.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

After the powerful restart for the US economy, the past few months have seen a reversal of the reflation trade that has driven stock markets higher. The Delta variant, combined with concerns that earnings, valuations and GDP growth are at or near peak levels also weighed heavily. Higher earnings plus reviving dividends should support equities, but investors need to be selective.

There are three key factors that drive share prices - earnings, fundamentals and valuations. It is worth noting that even at a time when economic recovery has been losing momentum, company earnings have been strong, especially among economically sensitive companies. Overall, companies have beat analyst expectations on both earnings per share (EPS) and revenue growth.

Revenue growth has also been particularly strong, suggesting that even with inflation driving an increase in input costs, companies have the pricing power to offset it. They have been able to raise prices and push higher costs on to the end consumer, a reflection of pent-up demand and consumers’ willingness to pay.

The market has consistently under-reacted to these stronger earnings numbers, particularly for companies in more economically sensitive areas. This suggests there may be room to manoeuvre in share prices.

Resilience on earnings

Of course, earnings may slow from here. Year on year comparisons will become more difficult and data over the last 20 years shows no precedent for sales growth to be sustained at these levels. However, recent results demonstrate corporate dynamism: companies have successfully managed costs through the crisis period. They have weathered inflation equally well, and we’d expect cost pressures to abate as pandemic-dented supply rebuilds and demand normalises.

This resilience on earnings is also a function of stronger fundamentals. Debt, where it exists, is largely manageable and balance sheets are strong. The bond market reflects this optimism: credit spreads ― the difference in yield between corporate bonds and Treasuries of comparable maturity ― are narrow. The limited yield differentiation between riskier and “risk-free” debt is a signal from the market that it sees a low probability of companies defaulting any time soon.

…we believe a focus on sustainability is crucial.


The high valuations of US stocks constantly draw criticism. Certainly, measured on a P/E basis, which values a stock relative to its prior or future earnings potential, they look expensive compared to the rest of the world and to their own history. P/E has typically been a poor predictor of near-term returns (one to three years) but has greater predictive power over the longer term (five to 10 years).

However, there are lots of unusual factors at work, not least the low interest rate environment that has persisted over the past decade. We believe that ‘equity risk premium’ (ERP) is a better gauge. It is a measure of whether investors are compensated for the greater risk in equities versus “risk-free” government bonds. The ERP has been well above its long-term average for the past 10 years, suggesting stocks are undervalued for the relative risk/ reward they offer.

Of course, there are risks. The Covid-19 virus has proved hugely unpredictable and could yet have a third act. This would derail investment markets. There are risks around the normalisation of monetary policy in the US and risks around valuations. Peaks and troughs are inevitable, but they don’t necessarily suggest the cycle is coming to an end. We see strong underpinnings for equities in the months ahead but believe there needs to be a focus on quality and stock selection.

Our positioning

The greater opportunity, in our view, is to be found in quality stocks. We are turning to this part of the market as the cycle’s next beneficiaries. There are a number of factors that support this rotation. On our analysis, not only are quality stocks the cheapest we’ve seen them since the dot-com era of the late 1990s, but our research finds that they also have a history of outperformance in the mid-cycle phases of a recovery.

We also see dividends coming back. As vaccines have paved the way for reopenings and recovery this year, companies have grown more comfortable in returning to more normal deployment of capital ― much of this in shareholder-friendly ways. Uncovering those companies seeing a revival in pay-outs is also a priority for the Trust.

Finally, we believe a focus on sustainability is crucial. This means looking through this short-term ebb and flow of markets to find companies with good governance, enduring business models, and whose products and services benefit society. This is where our Trust is focused, with the aim of delivering resilient returns for our shareholders whatever the economic weather.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of October 2021 and may change as subsequent conditions vary.