US funds sector review – Covid-19 continues to challenge the recovery

In July, the US economy surpassed its pre-pandemic size for the first time since Covid-19 hit, reflecting the economic progress made in the recovery so far. The US stock market is, at the time of writing, worth almost double its pandemic induced low in March 2020.

In months gone by we’ve seen the Federal government and the central bank (the US Federal Reserve (Fed)) continue their supportive policies to nurse the economy back to health. But it’s likely that the end of the central bank’s $120bn a month asset buying activities is drawing closer. The central bank is expected to start tapering this programme in the coming months, reflecting the improvement in the economy. They aren’t likely to raise interest rates anytime soon though. It’s predicted to be 2023 before we see any change there.

The Fed has altered its inflation target recently. It now targets an average inflation figure of 2%, alongside its other objectives. This means it will likely tolerate some periods of higher inflation like we’re seeing at the moment, if it’s been preceded by a period of low inflation.

Which sectors have been driving the recovery?

Over the past year, financials performed better than the other major sectors of the US stock market, rising 38%. The end of the election uncertainty and the positive news around vaccines towards the end of 2020 supported a brighter outlook for ‘cyclical’ sectors – ones with their fortunes closely tied to the health of the economy, like financials and industrials.

Chart showing performance of different US sectors

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Past performance isn't a guide to the future. Source Lipper IM, to 31/08/2021.

With household consumption accounting for around 70% of the US economy, US consumer spending will be key to the continuing economic recovery. This has the potential to generate higher inflation though.

Rising inflation is a topic that’s consistently grabbed the headlines across the pond. It reached 5.4% in the year to July, higher than the 2% average inflation target the Fed aim for. Top officials at the Fed, including Chair Jerome Powell, have been clear that they believe the increase will prove to be short lived.

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Past performance isn’t a guide to the future. Source: Lipper IM, to 31/08/2021.

A bumpy road ahead?

Recovering from an unexpected hit to the economy like coronavirus isn’t just as straightforward as getting consumers out and spending again. Bottlenecks in some supply chains have left companies short of key inputs which has increased the prices of some commodities and raw materials. So even if demand is increasing, these supply issues are limiting the ability of some businesses to ramp up production to match.

There are also fears that the pace of the recovery might be slowing as the delta variant continues to spread. American employers added 235,000 jobs in August, down from over 1million in July, falling well below expectations. This still leaves the US economy 5.3m jobs short of the number employed at the start of the pandemic. And restaurants & bars and retailers actually cut jobs in August, perhaps reflecting a worsening Covid picture.

With considerable differences between vaccination rates in different states, this is likely to be a continuing cause for concern in the months ahead.

If the recovery is stalling, the Fed might extend its supportive monetary policy for longer. This could push back the timeline for tapering its quantitative easing programme and raising interest rates. This would likely be positive for US stocks and help support higher valuations for longer.

How have the US Wealth Shortlist funds performed?

The strongest performer over the last year has been the FTF Royce US Smaller Companies fund which delivered a return of 39.9%*. This compares favourably with its IA North American Smaller Companies peer group average return, which was a gain of 36.9%. Past performance is not a guide to the future.

The fund’s manager Lauren Romeo looks for high quality small companies with above average returns on capital, trading at valuations below what they think they’re worth. The fund’s had a difficult few years but we think it harnesses the skill of a talented team with a sensible investment approach.

The weakest performer of our Wealth Shortlist selections in the North America sector over the past year was the Legal & General US Index fund. The fund has delivered a return of 25.9% to investors, compared with 27.7% for the FTSE USA index it tracks.

The fund uses a full replication approach which means it aims to invest in every company in the FTSE USA Index and in the same proportion. Despite this, tracking errors can occur meaning the fund delivers a different return to the index. Over the long term, we would expect its return to fall behind the index because of the costs involved in running the strategy, like taxes and dealing charges.

We don't expect all the funds on the Wealth Shortlist to perform in exactly the same way. We think it's important for investors to build a portfolio filled with managers who have different approaches and investing styles to help generate long-term returns.

All investments fall as well as rise in value, so you could get back less than you invest. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Investing in these funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

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Past performance is not a guide to the future. Source: *Lipper IM, to 31/08/2021.

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