US equities have had a rough ride recently. Are they still worth an investment?
The US equity market suffered a sharp correction last year, with the major stock indices posting losses that ranged from 25% to more than 30%. Despite these declines, the widely-watched S&P 500 index was still able to produce annual double-digit percentage gains over the past decade. In the first half of this year, the major stock indices bounced back strongly, with the S&P 500 actually managing to advance within about 6% of its all-time high from the turn of 2021/2022, after which it slipped back somewhat. At the moment, the valuations of equities do not look particularly cheap, and many market participants are worried about the prospects of a recession and rising yields on the bond markets. What can be done?
Stock indices only show part of the picture
It is important to understand that stock indices are always just a barometer, i.e. an indicator for a more or less representative part of the market, and that they can be misleading with regard to actual conditions for the broad majority of equities. For example, while the S&P 500 index is up by about 10% for the year to date, the index level would show no change at all if one removed the price increases of its seven largest equities (out of a total of 500 companies covered by the index).
At the same time, while there are many other stocks that have posted strong gains, there are also plenty that have suffered steep declines. With this, many US equities have already started to price in more gloomy scenarios for economic performance, corporate earnings, and interest rate conditions. In turn, this may mean that in the event of a recession these stocks actually have less remaining downside potential, compared to what the equity indices would appear to indicate. Conversely, a possible rebound for these equities may also go “unnoticed” in the major indices, just like the downward correction that they have already gone through.
Artificial intelligence is driving equity prices
There are several reasons for this uneven development of prices, and one of the most important is this year’s boom in artificial intelligence (AI). After the introduction of ChatGPT and the exceptionally strong quarterly figures released by the microchip producer Nvidia in the spring, stock prices shot higher for dozens of companies that had some kind of possible connection to the topic of AI. But the euphoria didn’t last all that long. Investors are now taking a very close look to see if there really is significant, realistic earnings potential for companies in this regard. In light of this, it also seems inappropriate to draw too many parallels with the Internet bubble from 1999/2000.
Impact assessment: The impact is calculated annually by Raiffeisen KAG.* The data shown relates to the companies in the Impact assessment fund Raiffeisen-Nachhaltigkeit-US-Aktien compared with the whole market.
Source: Raiffeisen KAG, own calculation, as of 28 June 2024.
Return and inflation as risk factors
Up to now, economic growth in the USA has been stronger than most market participants had anticipated. In particular, conditions on the US labour market have remained very robust. In turn, this could provide more fuel for inflation and make interest rate cuts in the near future less likely. For the equity market, this results in strong competition from the attractive yields on the bond market as well as higher financing costs for companies going forward. At the same time, many companies have been able to raise their prices to a larger degree than the increases in their costs, during this period of high inflation.
Clearly, one of the most important risk factors are inflation and interest rates. Renewed inflationary dynamics and/or additional increases in yields on bonds would be distinctly negative for the entire US equity market. At the same time, we do not currently identify any major risk of an intense, broad-based downturn on the market affecting all sectors and stocks in general. That said, there is also little basis for another strong uptrend on the market in general.
Are US equities too expensive in a global comparison?
Many investors are put off by the stock valuations in the USA, which are generally higher in an international comparison. On the one hand, this is understandable. On the other, there are good reasons for the higher valuations. The USA is the world’s strongest economic power, with enormous innovative energy. US companies are the dominant players in many of the cutting-edge technologies and markets of the future, for example on the Internet. The USA has vast natural resources, including large reserves of crude oil and natural gas. The country has the largest, most liquid financial markets, and – not to be underestimated – in a pinch it functions as a safe haven during difficult times on the global markets. As long as nothing major changes with regard to these factors, it is likely that the valuation premium on US stocks will remain in place. Accordingly, in our view this premium does not constitute an argument against the US equity market. Quite the contrary, in fact.
Good selection of equities will be crucial next year
Correctly identifying the companies and sectors that will be able to maintain their profit margins and those that won’t will be a very worthwhile exercise. In other words, one of the most important return factors in the quarters ahead will be picking the right equities. At this juncture, it is also important to note that investments in equities are affected by the conditions on the capital market and accordingly even an excellent selection of stocks is no guarantee for success.
Turning to the subject of corporate earnings: While declines were registered during the first half of the year (on aggregate for the market as a whole), most analysts project a rebound in earnings for the second half of the year as well as for 2024. Naturally, it remains to be seen whether this will materialise. At any rate, we see good opportunities for a number of companies, and the fund Raiffeisen-Nachhaltigkeit-US-Aktien is currently favouring firms from the sectors health care and information technology in particular. By contrast, the earnings situation for some companies in the field of consumer discretionary (i.e. non-essential consumer goods) will be more difficult.
ESG is attracting more and more attention in the USA as well
The USA lags far behind the Europeans when it comes to the topic of ESG. But this should change. Climate protection, sustainability, infrastructure, and ESG issues in general have been strongly supported by the Biden Administration, and not just with talk, but also with significant government funding and regulatory requirements. Companies that are active in these fields are receiving more support and will thus probably be able to better handle a stronger downturn in the economy. This should also provide additional support for many of the companies in Raiffeisen-Nachhaltigkeit-US-Aktien.
The fund Raiffeisen-Nachhaltigkeit-US-Aktien exhibits elevated volatility, meaning that unit prices can move significantly higher or lower in short periods of time, and it is not possible to rule out loss of capital.
*In order to calculate the effect of sustainable equity investments in the fund, we used the sustainability ratios of the companies found in their sustainability reporting. CO2 emissions are generally denoted in tons of carbon dioxide equivalents (CO2e), work accidents in lost-time-
injury-rate, waste in tons and water consumption in m3. The key ratios for the individual companies were multiplied by their weight in the fund or in the overall market, and the results of each key ratio were compared. Currently, we do not calculate such ratios for the bond segment of the funds, as we think that the "sustainable footprint" is attributable to the company owners, i.e. shareholders, not to the creditors, i.e. bond holders.