US quarterly review – uncertainty ahead?

Since the sell-off in the weeks leading up to the market lows of late March, US stocks have rebounded strongly. While lots of businesses are still operating well below capacity, whole sectors which initially shut down due to coronavirus restrictions are now at least partially back up and running.

In this US quarterly sector review we look at what's happened across the pond in recent months, and share our outlook for the economy, and the stock market. We also take a closer look at how different areas of the market have performed, including which funds have delivered the best returns.

This article isn’t personal advice. If you're not sure if an investment is right for you, please seek advice. Investments rise and fall in value, so you could get back less than you invest.

A country in recovery mode

We can see the size of the hit the US economy took in its GDP numbers. Between April and June GDP shrank by an annual rate of 32.9%, the largest decline since records began in 1947. But even this doesn’t paint the full picture.

Around one in five of the US workforce are still on some form of unemployment support. Why is this significant? Well in an economy where consumer spending typically makes up around 70% of economic activity, the government wants its citizens spending. But this income support provides a lower income, and is funded by the state – dealing a double impact to the economy. Providing this support, along with other coronavirus relief measures, means the country’s budget deficit has reached a record $3trn.

A government spending double what it generates from taxation is clearly unsustainable in the long term. But exceptional times call for exceptional measures. And difficult decisions will need to be made about whether to provide further support for the economy. More stimulus could add some firepower to the recovery but the belt will need to be tightened at some point.

There have been some promising signs of recovery though. In July 1.73m jobs were created, followed by another 1.37m in August. But even with these new jobs, this still leaves the total number 11.5m below the level before the pandemic. And according to a recent study this is all while the economy is operating at 80% of its level in early March.

While these numbers don’t exactly inspire confidence, it remains to be seen how long it will take and how difficult it will be to recover the final 20%. But the government and businesses alike will be hoping to see a strengthening of consumer demand in the weeks and months ahead.

Election season

To add to all of this uncertainty there’s also the small matter of the US Presidential election on 3 November 2020. Americans going to the polls will be choosing between re-electing current Republican President Donald Trump and Democrat nominee Joe Biden.

Typically in US election years, returns have been lower and volatility has been higher than in non-election years. Although this year, the impact of the pandemic on returns and volatility will hamper comparisons this time around with other election cycles. Most Americans will accept there’ll be an unprecedented impact because of the coronavirus. But the fact remains that Presidents facing re-election are more likely to win when the economy is strong. When it’s not, they’re much more likely to lose the vote.

In recent history the stock market has told a similar story too. Since 1960, in each of the four largest stock market drawdowns in which there was an election, the opposition has taken the White House. And while America is still grappling with new coronavirus cases, the stock market is likely to remain sensitive to the ongoing prevalence of the virus.

No-one knows for sure how the pandemic will play out and it’s too early to assess any full impact on the economy yet. So we think it’s important to make sure you have a well-diversified portfolio, focused firmly on the long term. The US is home to some of the world’s most innovative companies, who could well benefit from some of the changes we’ve made to our lives in the coming years. So we’re excited about the long-term opportunities that the world’s largest stock market offers, although there’s likely to be volatility along the way.

How have US funds performed?

The IA North America sector, which shows the average performance of funds investing in the region has lagged the FTSE USA index return over the last year. It returned 9.2%*, compared with the FTSE USA index’s 12.6% *rise. As always though, past performance isn't a guide to future returns.

Performance of US Sectors

Past performance isn't a guide to the future. Source: Lipper IM to 31/08/2020

The graph above shows how different sectors of the market have performed over the last year. Even with the impact of the coronavirus on share prices, most of the major sectors have still delivered positive returns. Perhaps unsurprisingly, given the boost the technology sector has received from the acceleration of existing trends, it’s stormed ahead. So funds with a high weighting to this area have also delivered strong returns.

On the other hand, 'value' focused funds which often have smaller weightings to the tech sector, haven’t performed as well. Funds investing with this style aim to find companies whose share prices don’t reflect their true value or earnings potential. This can often mean higher weightings in sectors like financials and industrials which haven’t done as well recently.

In the IA North America sector, the best performing fund over the last 12 months has been Baillie Gifford American. Co-managers Tom Slater, Gary Robinson, Dave Bujnowski and Kirsty Gibson invest around 28% of the fund in the technology sector. The team aim to identify stocks that should receive a tailwind by being on the right side of powerful trends. You can find out more later on in this sector review about which investments have been the biggest contributors to the fund’s strong performance. Remember 12 months is a short time over which to measure performance, and past performance isn’t a guide to the future.

Past performance isn't a guide to the future. Source: Lipper IM 31/08/2020.

Research team activity

We’ve spent the quarter continuing our deep analysis looking for fund managers with great performance potential investing in the United States. As ever, there are two parts to our fund analysis, the data-crunching quantitative, and the in-depth qualitative.

Our qualitative research included speaking with Tom Slater and Dave Bujnowski, co-managers of Baillie Gifford American and Cormac Weldon, manager of Artemis US Smaller Companies. Both funds were added to the Wealth Shortlist of funds chosen by our analysts for their long-term performance potential when it launched in June.

The Baillie Gifford American team invest in companies with high growth potential that they think are capable of delivering exceptional long term returns. They think few companies are capable of this, so run a relatively concentrated fund of between 30 and 50 stocks. So each one can contribute significantly to returns, although it increases risk. They also pay close attention to company culture, believing it to be an underappreciated driver of performance. Companies with a strong culture are often adaptable, durable and willing to invest for the future at the expense of short term profits.

Weldon at Artemis looks to invest in higher-risk smaller companies that he thinks have a 2:1 ratio of upside potential versus downside risk from the current market price. He does this by identifying what really drives the company. His team then spend time modelling what could happen to the businesses profitability and growth over time, as they’re likely to have the greatest impact on its future valuation. He then builds the portfolio with these ratios in mind. The fund only invests in 40-60 companies out of the thousands that make up the index which can increase risk.

Find out more about Baillie Gifford American including charges

Baillie Gifford American Key Investor Information

Find out more about Artemis US Smaller Companies including charges

Artemis US Smaller Companies Key Investor Information

How have our Wealth Shortlist funds performed?

Our Wealth Shortlist selections have generally performed well. We don’t expect them all to perform in exactly the same way though. We think it’s important for investors to build a portfolio filled with managers who have different approaches and investing styles to help generate returns.

The best performer over the last year by a considerable distance has been Baillie Gifford American, with a mammoth 77.3%* return. Like many other top-performing funds of late, the fund has benefited from the tailwind received by growth style investors. The fund is now co-managed by Tom Slater, Gary Robinson, Dave Bujnowski and Kirsty Gibson after Bujnowski replaced Helen Xiong earlier this year. The team’s investments in Tesla, Shopify and Wayfair have been among the most significant contributors to performance over this period. Although of course we’re pleased with the funds strong performance, it’s important to note that outperformance on this scale is rare and shouldn’t be viewed as a guide to future returns.

The weakest performer of our US selections has been the Legg Mason IF Royce US Smaller Companies fund, run by Lauren Romeo. The fund has lost 2.9% over the last year, although this is still ahead of its benchmark the Russell 2000, which lost 3.6%*. It’s important to take into account the manager’s focus on valuation which has been out of favour recently compared with other investing styles. We believe that the fund harnesses the skill of a talented team with a sensible investment approach.

Here’s how our Wealth Shortlist funds have done. For more details on each fund and its risks please see the links to their factsheets and key investor information below.

Past performance isn't a guide to the future. Source: *Lipper IM 31/08/2020.

Past performance isn't a guide to the future. Source: *Lipper IM 31/08/2020.

Find out more about Baillie Gifford American including charges

Baillie Gifford American Key Investor Information

Find out more about Legal & General US Index including charges

Legal & General US Index Key Investor Information

Find out more about Artemis US Smaller Companies including charges

Artemis US Smaller Companies Key Investor Information

Find out more about Legg Mason IF Royce US Smaller Companies including charges

Legg Mason IF Royce US Smaller Companies Key Investor Information

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