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Five reasons to keep faith in the US

Home / Press Centre / Five reasons to keep faith in the US

Mark Sherlock, CFA, Head of US Equities
17 July 2017
US Equities

Amid fears of an overheated market and uncertainty around Trump’s presidency, Mark Sherlock, Lead Portfolio Manager of the Hermes US SMID Equity Fund, believes there are still great investment opportunities to be found in the US small and midcap space.

A market driven by fundamentals

Year-to-date the Russell 2500 has returned circa 5.0% (compared with c9% for the S&P 500 Index). At a sector level, there has been a rotation out of some of the beneficiaries of the so-called “Trump trade” (banks, industrials) into parts of the market (healthcare, technology) which relatively underperformed in the post-election euphoria of Trump’s pro-growth policies. This rotation reflected the weaker economic data coming through in February and March and acknowledged a realisation that many of Trump’s policies are controversial and will likely require compromise. At the same time an improving European economy and Macron’s victory in the French Presidential election have seen investor interest switching from the US. These factors make for a better set up for the asset class- a market driven by fundamentals rather than one based on the expectation of political stimulus.

With this in mind, the market now appears to be more broadly representative of the robust fundamentals which underlie it. At the company level, several industrial businesses have called the bottom, and the deflationary effect of energy’s decline has begun to dissipate. The recent earnings season produced the highest revenue growth since 2011 and in many cases earnings are being revised up, reflecting increasing business confidence.

A fundamentally strong economy

We believe the macro-economic picture remains constructive for US companies - a healthy consumer, historically low unemployment, a stabilised industrial economy and, importantly, rising global GDP. In such an environment, the earnings of lean US businesses benefit from operating leverage. Valuations, whilst towards the top end of their trading range, reflect a healthy and improving underlying US economy. This benign backdrop can continue to support earnings growth for some time and we expect will drive further market appreciation irrespective of stimulative fiscal and economic policies.

SMID firms offer historical outperformance

US SMID stocks typically earn 70-80% of their revenue domestically compared with 50% for large caps, and thus should benefit considerably from any enhanced US economic growth.

Small and mid-cap companies have also historically outperformed the broader market in periods of rising rates – in particular the early stages, which tend to coincide with strong GDP growth and a benign economic backdrop; a context we are currently operating in.

Identifying businesses that deliver through the cycle  

While the US SMID market is attractive, careful stock selection remains vital. We look for quality companies with high barriers to entry and a durable competitive advantage bought below our assessment of their intrinsic value. We like companies that operate with defensible franchises that can deliver consistent and stable earnings growth whatever the idiosyncrasies of the macroeconomic environment.

Our large investment universe typically means it is possible to find interesting investments in all sectors. There is also a degree of information inefficiency in our sector of the market, whereas information related to large cap businesses tend to be more commonly known. 53 analysts cover Apple. Some of our stocks aren’t covered by any sell-side analysts at all, which allows us to build a differentiated portfolio, increasing our potential to outperform.

Disruptive technology is unearthing opportunity

In many sectors, the disruptive effect of technology has never been more evident - retail, autos and media being examples of sectors where structural challenges continue to test the accepted norms. Active stock-picking allows for a more thoughtful allocation to these uncertain parts of the market.

The US retail supply chain is rapidly being disrupted – and this is creating opportunity. As large and small players alike compete for shoppers across channels, we prefer to invest in the enabling technology rather than the brands on offer, which frequently fall out of favour with consumers. In supply chain software company Manhattan Associates, for example, we are not investing in a single consumer brand exposed to competition, but a business that is both enabling and benefitting from the growth of omni-channel sales: the ability to deliver goods to the consumer in-store, online or at click-and-collect desks in the most cost-effective way. Its software helps retailers optimise what is their most valuable and risky item of working capital – their inventory.

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Mark Sherlock, CFA Head of US Equities Mark joined the Hermes US SMID team in February 2009 as co-manager of the Hermes US SMID Cap strategy and became lead manager in October 2013. He became co-manager of the US All Cap strategy in May 2015. Mark initially joined Hermes in 2005 as an analyst and fund manager on the UK Focus Fund. Prior to this, he was an investment analyst at Rio Tinto Pension Fund, where he had responsibility for the small and mid cap portion of the portfolio. Mark qualified as a Chartered Accountant with PricewaterhouseCoopers in 2002. He has a degree in Politics from Durham University, is a CFA charterholder and a Fellow of ICAEW.
Read all articles by Mark Sherlock, CFA

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