US equities: running with the bulls

The Twitter-savvy 45th president has not missed an opportunity to inform his 44.1m followers who (he believes) is responsible for this unprecedented year of growth. “Looks like another great day for the Stock Market. Consumer Confidence is at Record High. I guess somebody likes me (my policies)”, he tweeted in late November when the Dow Jones smashed through the 24000 point barrier.

In the interest of fake news, it is worth noting that Mr Trump can’t really take all the credit. True, his proposed tax reforms are likely to have provided firepower between January and March. But by the summer it was the unprecedented earnings growth from the forward-thinking FANG stocks – Facebook (US:FB), Amazon (US:AMZN), Netflix (US:NFLX) and Google (Alphabet, US:GOOGL) – which were driving the gains, while a recovery in the energy and telecoms sectors provided the boost in the autumn.

So where next for US equities? Onwards and upwards, says Merrill Lynch. The US investment bank is forecasting a “mid-year correction”, but also thinks the S&P 500 will hit a record high of 2800 points before the year is over. Barclays agrees that 2018 could provide investors with “more of the same”, and thinks the economy will keep expanding due to a continued rise in consumer spending.

That said, Barclays is among a host of market watchers to have voiced concerns about valuations, particularly for technology and Bitcoin. A stumble in either of these has the potential to unravel the wider equity market. Meanwhile, the current bull market is ageing. If the S&P 500 keeps growing until 22 August 2018, it will have achieved its longest ever positive run. And yet no-one seems to want to call the top.

One thing we can be nearly certain of is that this time next year Mr Trump will still be tweeting. Other major trends, we can only make a guess at.

Trump’s tax

US corporate tax is mind-boggling. At 35 per cent, it’s absurdly high, but it is also dotted with so many loopholes that the treasury collects less tax than many fellow Organisation for Economic Co-operation and Development (OECD) countries. Donald Trump is on the cusp of changing that. His tax reforms – which include lowering the rate to 20 per cent, removing loopholes and ending the taxation of non-US earnings – have been approved by the Senate and could well become law in early 2018. His idea is that these reforms (and a one-off tax holiday which will allow companies with massive offshore deposits to repatriate their cash) will increase the amount of capital in the US, boost corporate investment and, ultimately, “make America great again”. 

In reality, investors are more likely to be the beneficiaries of these reforms. Why? Because many US companies are already beasts of cash generation. In the first nine months of 2017 the biggest 20 technology companies generated so much cash that they were able to comfortably pay $27bn (£20bn) in taxes, invest $55bn in capital expenditure and distribute $94bn in dividends and share buybacks. Even notorious spend-thrift Intel (US:INTC) and Apple (US:AAPL) – which built huge new headquarters in California and launched its most expensive iPhone in 2017 – returned more money to shareholders than they ploughed into capital expenditure.

Investors are therefore well placed for a big windfall in 2018 if Trump’s tax reforms become law. For example, Apple – which generates roughly 40 per cent of its earnings overseas – will save an estimated $47bn a year. That, plus the $252bn it has stashed offshore, would make a very welcome payday for investors.

Mega-merger mania

Two mega-mergers are readying themselves for analysis by US regulators. The first is the $69bn collaboration between pharmacy chain CVS Health (US:CVS) and insurer Aetna (US:AET). The second – which is yet to be agreed by management – is Walt Disney’s (US:DIS) proposed $60bn takeover of Twenty-First Century Fox (US:FOX).

Aside from the fact that they are mammoth deals, these two potential mergers have one common factor: tech giants lurking in the background. CVS is trying to bulk up its operation due to concerns about Amazon’s recent foray into the world of drug distribution. If the ecommerce maestro is as good at selling and delivering medicine as it is at everything else, CVS and its peers have every right to be nervous. Disney is feeling the heat from new TV companies such as Amazon (US:AMZN) and Netflix (US:NFLX). The rising popularity of online TV series combined with the improving quality of internet connections means US citizens are cutting their cable TV connections and turning digital.

To deal with the threat from tech giants, competitors are stacking up. At least, they are trying to. Telecoms group AT&T (US:T) proposed acquiring media company Time Warner (US:TWX) for $85bn back in 2016, but the deal is still battling through regulatory hurdles. Recently, the Department of Justice filed a lawsuit to block the merger because it claims it has the potential to stifle competition.

But regulators’ hesitancy in permitting mergers between medium-sized corporations is arguably quashing their aspirations to compete with new tech giants. By contrast, the US is doing little to curb the dominance of the biggest internet platforms. Amazon’s acquisition of Whole Foods went off without a hitch, Facebook and Twitter have been prolific in the spread of ‘fake news’ and Google would still be promoting its own products on its search engine if it wasn’t for the intervention of European regulators.

Earlier this year, the Yale Law Journal published Amazon’s Antitrust Paradox, which explained why American antitrust law has evolved to the point that it is no longer equipped to deal with tech giants. In 2018, that could change. Global governments are beginning to clamp down on the dominance of tech companies. Europe fined Google $2.7bn earlier this year and Australia’s competition authority recently launched an investigation into the market power of Facebook and Google (which are expected to attract 84 per cent of digital advertising in 2018). The Democrats want to alter antitrust laws to reduce this dominance and the Republican government could soon be under pressure to follow suit.

Pricey prescriptions 

Swiss pharma company Novartis (CH:NOVN) received US approval for its childhood leukaemia drug, which cured 80 per cent of late-stage patients in a clinical trial. The drug carries a $475,000 price tag. But don’t worry, if it doesn’t work (ie the patient dies), the family will get their money back.

It’s hard not to be angered by the state of the American pharmaceutical system. Prices are ridiculous, insurance cover is a mess and Donald Trump still can’t think of a decent replacement for Obamacare. But the Food and Drug Administration (FDA) is rattling through approvals of both novel and generic drugs at record pace in a bid to bring prices down, and this is creating a tough environment for the US pharma majors. These companies are going to have to step up the innovation and investment if they want to keep growing, making cash and paying their dividends.

Bet on quality

So, after sidestepping the minefield of political and economic turbulence in the US, what are the best options for investors who want exposure to the American dream? Index-topping funds are a good place to start. Beating US markets in 2017 has been a tough ask, but some funds have managed it. Investors can look to Baillie Gifford American (GB0006061963), Scottish Mortgage Investment Trust (SMT), Schroder US Mid-Cap (GB00B7LDLV43) and Loomis Sayles US Equity Leaders (GB00B8L3WZ29) if they think the same trends will pan out in 2018.

But these all benefited from the sky-high growth of technology companies, which even the most bullish of market commentators don’t think can continue rising at the same pace indefinitely. To avoid the pitfalls of speculative mania surrounding US tech, we’ve picked out 14 companies whose price-earnings valuation sits below the top fifth of all stocks in the S&P 500. We’ve screened for genuine quality metrics, defined by stock screen guru Algy Hall, and highlighted the companies that are likely to be solid bets in the next 12 months.

Solid US bets for 2018