Is the US stock market cheap enough to invest in again?

Many investors view long term US prospects favourably but have shied away from pricey valuations in recent years.

The US market carnage might now be reaching the kind of pitch where they are willing to buy in or start adding to existing holdings again.

The stock market falls are being triggered by fears about inflation, and that the tough action needed to counter it – higher interest rates – will push the world’s biggest economy into recession.

This is being accompanied by a huge sell-off of US government bonds, because as interest rates start to rise bond yields do too to keep luring buyers.

That makes the yields from older existing bonds look less attractive so investors dump them in a hurry, causing bond prices to plunge.

But if you are a long term investor, a nasty bout of inflation and even a recession might be seen off within a few years.

See the S&P 500 charts below, which show bad shocks but eventually no interruption to the upward trend in the market (with, of course, the important caveat that past performance is not a guide to future returns).

But might the ructions on US financial markets mean they are getting cheap enough to be worth a fresh look? Financial experts explain recent developments and where investors might find opportunities below.

What is going on in US financial markets?

‘Next Monday is Independence Day in the US, but investors have little to celebrate,’ says Darius McDermott, managing director of FundCalibre.

‘Both US equity and bond markets have had a shocking 2022 so far. April was only the fourth month in nearly 50 years that the S&P 500 fell more than 5 per cent and US treasuries simultaneously fell around 2 per cent.’

McDermott says the situation has not improved and this month headline inflation topped 8 per cent, while the US stock market entered bear market territory meaning it has fallen more than 20 per cent from its peak.

But he says the US stock market currently looks more attractive to him than for a long time, because valuations were high after it led global markets for almost a decade, and it was difficult to justify adding to holdings.

‘Now the froth has come out of the market, a number of areas are looking much better value, including smaller companies and the large mega-cap tech stocks.

‘I expect to see continued market volatility as the rate hiking cycle continues, and the risk of recession is increasing, with many believing it is a matter of when, not if, it occurs.

‘But markets move ahead of economies and much of that risk I believe is already priced into valuations.’

McDermott warns prices could go lower in the short term, though in the long term there are opportunities for investors – find his fund tips below.

Ryan Hughes, head of investment research at AJ Bell, says: ‘The US market has been in a real quandary recently as investors look to try and judge where the Federal Reserve will go with interest rates.

‘The shift in narrative from inflation being a short term worry to a longer term issue has caused havoc in the equity market with the some fashionable technology stocks taking a battering this year while areas such as energy and healthcare have done very well. ‘

Hughes says investors looking at the US should be conscious the make-up of the market is very different to the UK, with technology making up nearly 30 per cent of the S&P 500 index.

Apple, Microsoft, Amazon, Alphabet and Tesla make up the five biggest positions, he points out.

‘As a result, the market remains susceptible to the uncertainty over interest rates as further increases will likely see the technology sector struggle which could hold back the US market in the short term.’

What about bonds?

‘There’s a big difference between buying US government bonds (no credit risk) and US corporate bonds (credit risk) at this point in the economic cycle,’ says McDermott

‘Generally, the higher you go up the risk curve in terms of credit risk the closer your correlation is to equities. So high yield bonds and equities will often move in a similar fashion.’

He likes US government bonds at the moment, because they can be negatively correlated to equities at times of stress. McDermott says this means they are an excellent portfolio diversifier.

‘The issue for many years is they’ve just offered such bad value but, at over a 3 per cent yield, we can at least consider them again.’

US fund tips to consider for your portfolio

Darius McDermott of FundCalibre and Ryan Hughes of AJ Bell offer the following suggestions if you are thinking of buying into the US or topping up your holdings.

Darius tips…

JPM US Equity Income (Ongoing charge: 0.78 per cent)

Despite the naturally lower yielding nature of the US market, it has a long history of dividend payments, an increasing number of companies now paying a dividend and a number of dividend aristocrats – companies that have increased their dividends for 25 consecutive years or more.

JPM US Equity Income fund targets an above-average income by investing in a diverse range of established stocks.

T. Rowe Price US Smaller Companies Equity (Ongoing charge: 1.04 per cent)

The manager of this fund looks for both growth and value opportunities in the small-cap space, to build a diverse portfolio of the best ideas from the vast analyst resource at his disposal.

He will allow his winners to run as long as he still believes there is a return opportunity, and will also invest in areas such as biotech, which other generalist funds often avoid.

Schroder US Mid Cap (Ongoing charge: 0.89 per cent)

Run out of New York by Bob Kaynor, Schroder US Mid Cap has a focus on small and medium-sized companies, with a diversified set of return drivers, in order to dampen the risk of the overall portfolio.

The investment process is underpinned by in-depth company analysis, which has led to superior stock selection over time.

AXA Framlington American Growth (Ongoing charge: 0.82 per cent)

Innovation, unique brands, and intellectual property are the sort of features that can give companies a competitive advantage, helping them grow into market leaders.

These kinds of stories are what manager Steve Kelly and his team hope to uncover for this fund in their quest for growth stocks in the US market. Around a third of the portfolio is typically invested in tech stocks.

Brown Advisory US Flexible Equity (Ongoing charge: 0.88 per cent)

The manager of this fund primarily seeks out undervalued medium to large improving businesses, which rewards the fund with good liquidity (ability to buy and sell easily) and decent growth prospects.

Companies with recent management change offer particular appeal. The unconstrained strategy has enabled the fund to become of the few to consistently outperform the S&P 500 over long periods of time.

Invesco US Treasury Bond 7-10 Year UCITS ETF (Ongoing charge: 0.06 per cent)

This is a cheap easy way to get access to the asset class. You can buy either a hedged or unhedged version. We currently prefer the unhedged version as the US dollar tends to be risk-off (meaning it usually strengthens versus sterling in times of stress) and this is part of our defensive allocation.

Man GLG High Yield Opportunities (Ongoing charge: 0.75 per cent)

US and European high yields tend to be quite different markets. I believe the US market is generally more cyclical.

Mike Scott, manager of Man GLG High Yield Opportunities is cautious on the US high yield market and prefers Europe and the UK.

Generally, we are cautious on high yield at the moment. Although credit spreads have widened we think they have further to go. We are looking to reduce credit risk from our current bond exposure.

Ryan tips…

iShares Core S&P 500 ETF (Ongoing charge: 0.07 per cent)

For investors wanting exposure, the US market is very difficult to beat for active managers and therefore gaining cheap, passive exposure via a tracker could be a sensible approach.

JPM US Equity Income (see above)

For those wanting an active manager, the JPM US Equity Income fund provides a core exposure with a tilt towards income producing companies and holds less in those big technology companies, making it a good diversifier.

While it has lagged over the longer term, it’s come into its own during the past year, helped by exposure to areas such as oils and financials.

Artemis US Smaller Companies (Ongoing charge: 0.87)

The US market is more than just the big companies, with a thriving smaller companies market as well, albeit these smaller companies are much bigger than you will find in the UK.

For exposure to this area, the Artemis US Smaller Companies fund has good pedigree with an experienced manager, backed by a strong team.