Threadneedle first thought on US Equities
On the eve of Independence Day, Cormac Weldon, head of US Equities at Threadneedle Investments, makes the investment case for US Equities:“This year both the Dow Jones Industrial Average and the S&P 500 reached record highs, proving that US equities continue to merit a place in any well-balanced portfolio.
“While any upward move is often accompanied by spells of volatility, it is our belief that the US is still the powerhouse of the global economy and the market’s future potential remains bright: the US stock market is the biggest in the world, offering investment opportunities in some of the world’s most successful companies, from traditional businesses such as PepsiCo, to companies at the cutting edge of technology, such as Google and Microsoft. Coupled with America’s well known entrepreneurial spirit and long history of ground-breaking innovations, the case for investing in US Equities is persuasive.
The credentials for US investment:
Inflation expected to decline - while the Federal Reserve remains concerned about current inflationary pressures, we believe the outlook appears more benign with a slowdown in the US economy helping to moderate inflation during the second half of 2007.
Interest rates have probably peaked - rates are still comparatively low from a historical perspective, which is helping to fuel the current frenzy of M& A activity. Both publicly listed companies and private equity firms are able to raise funds at attractive rates to help finance takeover bids.
US consumer finances in reasonable shape - while consumer spending has been weak at the lower end of the market, demand for high value items has remained firm. Overall, the consumer is in a strong position, with healthy income growth and unemployment at historically low levels. The jobs market remains underpinned by the service sector and government posts.
US economy continuing to expand - although we expect US GDP growth to slow to 2.2% this year, as against 3.3% in 2006, this still represents a benign environment for US companies. Furthermore, growth in Q1 2007 was hindered by companies drawing down their inventories and this process appears to be coming to an end. Indeed, companies may now increase production slightly in order to rebuild their stocks. Additionally, while the downturn in the US housing market had a dampening effect on economic activity, this has been partly alleviated by the ongoing strength of commercial construction.
A more stable dollar - the US dollar has weakened markedly over the past year against other leading currencies. However, the case for the dollar is now more balanced and we expect the currency to prove more stable over the remainder of 2007 and into 2008. At current levels, the dollar looks good value on a purchasing power parity basis versus the euro and sterling.
Robust corporate earnings - US corporate earnings growth remains healthy and we are currently forecasting a figure of 7% for 2007 and 2008. While this represents a slowdown from last year, amid the slower pace of economic activity, our estimate could well turn out to be on the conservative side. Combined with a prospective dividend yield on the S&P 500 index of over 2%, investors are looking at potential returns of around 9% or more this year without any added alpha from our fund managers or allowing for the additional kicker of a recovery in the dollar.
Attractive valuations – at current levels the US equity market continues to look attractively valued. The prospective P/E for 2007 is just over 16x, which is significantly below the 10-year average. At these levels the US equity market is moving close to parity with its major competitors and, with many high quality US companies on attractive valuations, an extremely fertile environment, full of investment opportunities, has been created for our fund managers to exploit.
Corporate activity a major driving force - Cash flow remains very strong at a time when net debt of publicly quoted companies is at its lowest in approximately 20 years. The rise of activist shareholders is exerting pressure on companies to allocate capital appropriately and to return cash to shareholders, which we support. In addition, private equity firms still have plenty of firepower to pursue acquisitions, whether these are financed by loans or uncommitted capital.”
Additional information:
Forsyth-OBSR recently upgraded the £845 million Threadneedle American Fund managed by Andy Holliman, and the £557 million Threadneedle American Select Fund managed by Cormac Weldon, from A to AA because of consistent and strong performance.
Both American funds have consistently delivered top quartile performance above its peers in the IMA North American sector. They have also consistently outperformed the S&P 500 over all time periods – one, two and three years, see chart below. Performance data source: Micropal, bid to bid, net income reinvested, to 31 May 2007. All figures in per cent.
The Threadneedle American Fund and the Threadneedle American Select Fund are run along different investment mandates, such that they possess differing characteristics and thus differing performance expectations:
The Threadneedle American Fund is a core diversified equity portfolio. This fund seeks to deliver top quartile medium and long term total returns, with relatively low levels of volatility.
The Threadneedle American Select Fund is a more concentrated core equity portfolio. This fund aims to achieve top quartile medium and long term total returns. Being a more concentrated portfolio than the Threadneedle American Fund, with larger conviction holdings, it aims to achieve high levels of total returns, however this results in higher levels of volatility.
There are eight fund managers in Threadneedle’s North American equity team, one of the largest entirely based in London. Each investment manager has research and fund management responsibilities and places significant emphasis on teamwork. Research is integrated and typically organised along sector lines so that each fund manager has primary responsibility for specified sectors and stocks.