Paul Quinsee, Chief Investment Officer, US Equities, JP Morgan Asset Management, gives his views on the US equity market.

Paul Quinsee, chief investment officer, US Equities, JP Morgan Asset Management, gives his views on the US equity market. After a strong year in 2013, what does the future hold? As always, the views expressed here are not necessarily shared by this publication but it is pleased to share these insights with readers. (A brief description of a fund operating in his team, with figures, is given below.)

After 2013 was the best year for US equity investors since 1995, what’s next? If we look briefly at lessons learned last year, we saw for US value investors that the classic contrarian measures of stock selection (low price/earnings, low price/book value and low price/free cash flow) all paid off very well during the year, as confidence grew in the prospects for continued economic recovery. But for growth investors, excitement around innovation in biotechnology and mobile technology also provided some powerful investment themes, and the Russell 1000 Growth benchmark actually slightly outpaced the Value version in what most would consider a banner year for the value style.

If we turn to the outlook, what can we expect in 2014? We foresee a modest acceleration in profits growth. From a longer term point of view, we think that profits are roughly in line with trend.

That comment is actually a strong statement to make, with net profit margins for the S&P 500 companies hovering around 9 per cent, well above historical average. But we think many of the drivers of these high margins are long lasting. For example, multinational US corporations are major beneficiaries of globalisation and technological change. We think that will persist over the next 5-10 years.

Lower interest rates and lower taxes have also helped boost profitability.  Some of those benefits may gradually fade over the course of the year. However, we think that higher interest rates may actually improve profits initially, with low returns on cash and low interest margins in the banking sector depressing returns during the era of so-called zero interest rate policy. Meanwhile we would also expect some help for company revenues from acceleration in the pace of economic recovery in the US this year.

A prediction for US earnings growth of around 8 per cent is our best guess for 2014, helped by continued buybacks of equity at a rapid pace, and probably again sweetened with faster growth in dividends as cash flows remain so strong.

Rationally US equity investors should expect much less of a rise in price/earnings this year. The starting multiple on our normalised estimates is now 16x compared with 13x a year ago and 9x at the depths of despair in early 2009. So we have to be realistic, the market has come a long way.  

Cheap
Stocks still look very inexpensive in comparison to bonds but we see little reason to doubt the consensus view that bond yields will be rising again in 2014, gradually making this comparison less attractive. There is of course a chance that the stock market overshoots fair value and produces another strong gain this year. Investor sentiment does appear to be improving considerably, raising the chances of some old fashioned irrational exuberance and a dangerously overpriced market as a result. It also seems sensible to prepare for higher volatility in stock prices, after a remarkably calm experience in 2013 that isn’t at all typical of the longer term history of equity investing. Expectations are higher now, and the transition away from the most accommodative monetary policy ever seen probably carries some risks as well.

Within the market, the opportunities for stock picking would seem to be in the same places as last year, at least for now. After such strong price movements, our value-minded investors have become less excited about the outlook, but still see plenty of attractions in the financial group and in more cyclical names. Defensive groups still look expensive, although we are starting to find a few opportunities in utilities and REITs. Our growth team saw more opportunities as last year progressed, within consumer and industrial groups as well the traditional sectors of healthcare and technology. Last year’s gains have however resulted in some richly priced companies in this group, and careful attention to the fundamentals will be required in 2014.

Editor’s note: A fund that illustrates the thinking of the author is the JPM America Equity Fund, which was recently made available to UK onshore investors as an OEIC. The fund managers named on this strategy – Jonathan Simon and Greg Luttrell - report directly to Quinsee. The fund has a concentrated portfolio of 20 to 40 stocks, combining ideas from US Growth and US Value teams. In 2013, the fund outperformed the S&P 500 Index of US equities by 8 per cent, the firm told this publication.