Andy Brunner, investment strategist at Morningstar OBSR, says US equities area facing a number of challenges…
The US is leading a modest rebound in the global economy which most commentators expect to continue through next year. Despite this, a period of higher volatility seems likely as US equities face a number of challenges, not least being they are fairly fully valued, and have avoided a correction for several years.
Another key challenge now facing the US equity market is the end of QE, with investors rightly concerned about the Fed’s campaign to normalise interest rates and the consequent impact on financial markets. The dollar’s recent surge is one manifestation although, as yet, bond yields have yet to rise as they have at similar junctions in the past. Higher yields have probably only been delayed and most commentators expect them to rise gradually over the next six-nine months.
Can the US equity market cope with these trend changes? In the medium term the answer is probably yes, as long as consensus expectations for economic growth and inflation are realised, external factors are not overly destabilising and corporate continue to deliver progressively higher earnings. But, the QE driven, low volatility ‘period of certainty’ enjoyed for most of the past two years is at an end and investors should be prepared for a period of lower equity returns, higher levels of volatility and even the odd correction.
One of the reasons for expecting lower equity returns is the much reduced scope for further valuation expansion – the elastic may have already been stretched too far. Additionally, synchronous worldwide economic recovery has failed to develop despite the enormous support provided by the authorities. Thus, risks from US growth and exogenous factors are real and could still potentially derail the bull market yet.
For now, however, the long term bull market remains intact even if the period ahead is a much more turbulent phase for investors. The upside for US equities may not be excellent, but potential returns over the next 15 months should still outperform bonds and cash
