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Investors in U.S. stocks are expected to remain cautious in the coming months, keeping valuations down, despite positive economic news and widespread expectations of a reversal of monetary policy in the coming quarters, according to two market experts. need to recognize.
“The market is pricing in two rate cuts later this year, but I don’t believe it,” said Fran Radano (pictured) at Abrdn, manager at North American Income Trust (Nait). . “Monetary policy works behind the scenes, but the Fed started its rate-hiking cycle six months too late and will not risk cutting rates too soon.”
Eric Papesh, U.S. Equity Portfolio Specialist at T Rowe Price, agrees that the central bank “is in a tough spot” given its dual focus on price stability and the labor market. “Our base case is a slower pace of tightening, but it means that even if interest rates rise by 25 or 50 basis points, they will still be higher than they are today. It is only a matter of time before it affects sales, margins and profits in the real economy.”
Both Papesh and Radano feel that the U.S. stock market rally so far in 2023 may be based on false optimism. “The S&P 500 is now over 4000 and at this level it doesn’t factor in a recession,” says Radano. At a consensus earnings estimate of $225, the index’s forward P/E valuation is currently 18x, but at a more realistic earnings figure, he’s at $200 (again, the number quoted by his Papesh), so the multiple is his 20 times more, he explains.
“And a 20x P/E with the Fed rate approaching 5% seems grossly overvalued,” he says.
branch market
Radano’s income restrictions have led him to avoid some of the most valuable sectors in the US market. These sectors have been the major drivers of index returns in the post-global financial crisis period for all but the past year.
“Valuations, earnings and cash flow start to matter when the cost of capital is non-negative,” he said, adding that the market is dominated by 22-23x P/E multiple growth stocks and 22-23x value stocks. Point out that the polarizing of greater than that remains. Given the manager’s relatively defensive positioning, the average forward P/E for the Nait portfolio is 13x him.
“We are not superhuman bears hiding in telecoms or utilities. We maintain a diversified portfolio, but stay away from the more cyclical, high-beta names,” Radano said. explains. The portfolio’s average dividend yield is over 3.5%, and dividend growth is in the mid-to-high single digits, giving the manager ample cushion in an environment where dividends are expected to play a larger share. and provide a margin of safety. total return.
“Historically, dividends have accounted for one-third to one-half of the total return, but over the past decade they have been 10-15%. ” Nait’s largest sector weights are now financial, healthcare and energy, with relatively low exposure to consumer names.
T Rowe Price is known as a growth investor, but about a third of its U.S. equity assets are in Papesh’s areas of focus: Core and Value. Portfolios he’s working on are “more defensively leaning on the margin,” he said, and were less cyclical in early 2022 given market volatility. This is a strategy that has worked to our advantage.
However, he argues that the timing of this move is crucial. That was nine or twelve months ago. “
Instead, he’s leaning toward “controversial” sectors, now with more compelling valuations, and opportunities in areas such as consumer, tech and industrial stocks. but only in areas where the balance sheet, management team and business execution are important. strong.
Examples of stocks that have risen in the long term but whose valuations reflect short-term challenges include Stanley Black & Decker. Electronics store Best Buy. and computer storage name Western Digital.
number of yellow flags
Given the ongoing debate over the state of the U.S. economy, Papesh said the goal is to “build a well-balanced portfolio without risking the broader direction of recession and a soft landing.” increase.
Radano is a little more cautious. [of controlling inflation while not inducing a recession] is hard to imagine. We don’t need to see ‘blood in the streets’ as Sir John Templeton put it, but if employment were to be eliminated a little bit, consumer spending would fall and the consumer would lose his share of his GDP. It will be 65-70% – there are many yellow flags.”
Meanwhile, Peter Hargreaves, chairman of technology-oriented asset manager Blue Whale, recently advised UK-based investors to address their underweight to the US, calling it “the safest economy. It seems prudent to look for large, successful companies.” For equity professionals at least, a better-thought-out, valuation-aware, and stock-specific approach could be the key to winning in the world’s largest stock market.
February 1, 2023 by Sarah Godfrey
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