US market review: what are the prospects for investors?

The US is by far the world’s most important share market, accounting for almost two thirds of global stock market worth. It means that investors taking a ‘neutral’ approach to asset allocation should have about this amount in the equity component of their portfolio.

Yet many UK investors do not allocate as much as this, and over the past decade this will have been a missed opportunity. The US tech and ecommerce giants, including the so-called ‘Magnificent Seven’, in particular have swelled in value, fuelled by expectations of growth led by artificial intelligence. Exposure to these, and the US market more broadly, have helped propel portfolio values upwards.

A passive approach of simply following an index, such as the S&P 500 has also therefore produced strong returns. The passive, or tracker, funds on our Preferred List are Fidelity Index US and Vanguard S&P 500 UCITS ETF, which both offer simple and cost effective exposure – and a strong option in an area that active managers, who try and beat the index, sometimes struggle to outperform. This has particularly been the case over the past decade given the level of concentration in the US market. The biggest stocks in the index outperforming means a natural headwind for active managers, who tend to be underweight the behemoths.

However, the rally in the US market broadened out more recently, offering more opportunities for stock pickers. This is illustrated by some good performance from many of our actively managed Preferred Funds in the sector over the past year. The trend has partly been caused by the US economy exceeding expectations and aided by ‘reshoring’ industrial production and robust infrastructure spend. This time last year many commentators were convinced a US recession was around the corner, but now expectations point to a shallow downturn or none at all.

The US consumer has been notably resilient, and somewhat immune to the higher interest rate environment as most mortgages are fixed for decades. Many borrowers had locked into low rates a few years ago. The fly in the ointment for investors is that a stronger US economy has kept inflation higher and dampened hopes of interest rate cuts in the near term. The number of cuts expected in 2024 has fallen from around six at the turn of the year to just one or two. However, more recently, the economy has been sending decidedly mixed signals with both growth and jobs cooling by more than expected.

Overall, it means there could be volatility ahead as the inflation picture evolves and the US election looms large. Some companies may also disappoint if the reality of earnings results doesn’t meet what investors have hoped for. For now, though, the current era of US exceptionalism seems to be intact. On average, businesses have handsomely beaten expectations in the most recent earnings season. As ever, the size and dynamism of the US market is far too big to ignore.

Recent investment fund performance

Past performance is not a reliable indicator of future returns. Figures are shown in £ on a % total return, bid to bid price basis with net income reinvested; Source: FE Analytics, data to 30/04/2024.

US funds to consider

1. Artemis US Extended Alpha

The manager looks to ‘extend’ the stock market opportunities available by supplementing a traditional portfolio with additional and offsetting ‘short’ positions that benefit from falls in the value of a chosen investment. The market exposure in the fund can therefore vary between 85% and 115% but is typically around 100%.

The past year has been a strong period for stock selection, and getting allocation to the mega cap tech stocks right has been an important part of this. Over 2023 the fund benefitted from owning Meta (the owner of Facebook), Amazon and Alphabet, which the managers considered undervalued, before taking some profits in Meta. From this time last year, the fund also added Nvidia and maintained that position. Conversely, the fund was less exposed to some of the poorer performing large stocks, notably Tesla and Apple.

We retain confidence in the management team’s stock selection capabilities and the level of differentiation it can provide from its peers and the broader index. With the long/short element it has the ability to keep up in rising markets but also protect capital during times of market stress – though this is only the case if the managers get their tactical approach right. It should also be noted that a performance fee adds to the cost of the fund if it provides market-beating returns.

2. Brown Advisory US Sustainable Growth

Run by Karina Funk and David Powell, this fund’s approach prioritises sustainable and steady growth when assessing company prospects. Each company owned must have a ‘sustainable business advantage’ which helps clarify the team’s thinking on how sustainability can help drive revenue growth. Holdings are on average higher quality, higher growth, and often trade at higher valuations than the benchmark average.

Exposure to big tech once again assisted performance over the past year, albeit to a limited extent as the fund has a 5% maximum position size in a single stock, which can limit exposure to the mega caps. Around two thirds of the portfolio is invested in lower but more durable growth stocks, and the tilt towards more defensive, stable businesses has served the fund well amid the difficult economic backdrop and rising interest rates.

Elsewhere, stock selection has been more mixed with losses sustained on Block and Bio-Rad Labs. Enphase Energy also detracted, while ServiceNow and Intuit contributed. Not owning Tesla or Apple owing to growth concerns was a further positive to a comparison with the wider market. Going forward we can expect the fund to retain a tilt to the technology sector. Lead portfolio manager Karina Funk told us she particularly likes AI adopters that have a ‘competitive moat’.

3. Fidelity American Special Situations

This fund takes a contrarian, value-based approach with the managers Ashish Bhardwaj and Rosanna Burcheri aiming to uncover businesses that are unappreciated and therefore cheap to buy. The aim is to provide a ‘margin of safety’ by buying into fundamentally sound companies below their true worth. As such the manager avoids more expensive shares and the fund has almost entirely missed the rise of ‘big tech’ over the past decade. To guard against ‘value traps’ stocks have to possess an identifiable long-term tailwind and not be part of a ‘dying’ industry.

Not holding Microsoft, Amazon and other successful tech heavyweights has hampered relative performance versus the S&P 500 over the period, although the fund has captured the broadening out of market returns while staying true to its value-based approach. It also had an excellent period in 2022, meaning that medium- and longer-term performance numbers are respectable, especially given an approach that has been at odds with market trends for much of that time.

The team believe Alphabet is the only one of the ‘Magnificent Seven’ stocks that ‘makes sense’ on valuation grounds, and this is held in the top ten holdings. The rest of the fund has little in common with the makeup of the broader market as some less dominant areas are prioritised. A key theme for the fund in 2023 has been ‘onshoring’ – companies that are the beneficiaries of US fiscal policies, such as the Inflation Reduction Act. For instance, the managers added Jacobs Solutions, an engineering firm and Norfolk Southern, a railway company.

Energy stocks contributed the most to returns for the fund over the past year. The companies selected were on the basis of energy resiliency and being enablers of solutions. However, this did not make up for the biggest sector allocation detractor of technology, a result of no exposure to Nvidia, Microsoft, Meta, Apple and Amazon.

4. Jupiter Merian North American Equity

This fund takes a systemic, quantitative approach, driven by data science, and tends to deviate less from major US equity benchmarks compared to many actively managed funds. The strategy assesses companies against five key characteristics the team believe have predictive power of future stock price movements. Its style will ‘flex’ across different macroeconomic conditions, meaning it cannot be categorised as either a ‘value’ or ‘growth’ strategy, though the portfolio will have an overall tilt towards certain value and quality factors, as supported by academic evidence.

A narrow leadership market environment isn’t ideal for his strategy, but manager Dr Amadeo Alentorn told us he believed his team navigated it well. In accordance with its systematic process, the fund only has a +/-1% deviation in each of the dominant Magnificent Seven, but it was still able to carve out some outperformance of the index over the period from positive stock selection in other sectors. The fund has been slightly overweight Apple, Nvidia, and Meta, with underweights in Tesla, Microsoft and Amazon.

Going forward, Alentorn expects broader drivers of stock market returns, which could be more fruitful for both fundamental and systematic active managers going forward. We think it is important to consider a range of stock selection processes for the US market, which will be most investors’ largest regional equity allocation. The periods of outperformance of the strategy have historically had a low correlation to more stylistically driven portfolios, so it could appeal to those who want a diversifier within their US equity allocations that is complementary to a higher-conviction active fund.

5. Premier Miton US Opportunities

Managers Nick Ford and Hugh Greives have a bias away from larger businesses and towards mid-sized US companies. Their approach results in a concentrated and differentiated portfolio that can add to risk but result in meaningful outperformance if they get their stock selection right – and underperformance if they don’t. The duo’s process centres on identifying quality companies and paying appropriate valuations, taking a more nimble and pragmatic approach wedded neither to growth nor value stocks.

The fund could be a good complement to a US portfolio allocation dominated by mega-cap tech heavy trackers. It is significantly different to the S&P 500 Index and has never held the likes of Alphabet, Meta or Amazon. The team are very sceptical of the AI boom, notably so of Nvidia. The top holding is a typically unfamiliar name, Graphic Packaging, a paperboard and paper-based packaging business operating for some of the world’s most recognised brands of food, beverages and personal care products.

Following a difficult period over much of 2023, the fund has started to perform better as market leadership has passed from the tech heavyweights to a greater breadth of companies, including smaller businesses. Small and mid-caps are historically inexpensive, and this is where the bulk of the fund’s assets are allocated, with just a quarter of the fund in the top half of the S&P 500. Combined with a concentrated portfolio of fewer than 40 stocks, it results in just a 93% active share versus the index.