As we wait in line for our vaccinations, each day the prospects for the economy seem brighter. Investors face a tricky decision. Should they look for companies and countries yet to recover from a dire 2020 or stay with areas that thrived during the pandemic?
Valuations may influence your choice. If your portfolio reflects the shape of global markets, you will have significant exposure to the US. Looking at the average multiples of earnings for each stock market, the US appears expensive today. The S&P index is close to 20 times earnings and yielding 1.5 per cent, according to Bloomberg. This compares with the UK’s FTSE 100 at 12.8 times earnings and a yield of 3.2 per cent, which seems more secure after last year’s dividend cuts.
Some might call that an argument for investing in the UK and add that you avoid currency risk in the process. Over the long term, the currency where a company makes its profits should determine its value and the exchange where the shares are quoted should matter little. Large companies sell in all the world’s currencies — whether their shares are quoted in sterling or US dollars does not change the underlying earnings.
The valuation argument is less compelling when you dig deeper, too. Before taking money out of the US, investors should bear in mind that these headline figures are distorted by a market that contains large technology stocks on very high earnings multiples. The UK index has a much higher weighting to banks and oil companies, which trade on modest multiples.
The largest US companies are growing fast: revenue growth for Apple this year is forecast at 21 per cent, Microsoft at over 14 per cent and Amazon at 22 per cent. They need high investment to support this growth, and this is deducted from declared earnings — partially explaining the high price-earnings multiples. Tesla tops the list, on 205 times earnings.
Though the Faangs — Facebook, Apple, Amazon, Netflix and Google/Alphabet — are far from facing imminent doom, we should not assume they will maintain their dominance. Consider how much the leadership of the index changes: Apple, Microsoft and Amazon lead today, while Exxon (#1 in 2013) is now 28th, IBM (#1 in 1985) is 67th and General Electric (#1 in 2000) is 73rd by market value. European markets seem to rotate their largest stocks more slowly.
Look beyond the US mega-cap stocks and you start to see the extraordinary breadth and depth of American capitalism. We are living through a period of rapid innovation in semiconductors, software, cloud applications, automation, materials science and biotechnology.
Most of the companies I will highlight as illustrations here are held in funds I co-manage. I know them well. But there are plenty of other stocks that have powerful business cases. With as many as 6,000 companies listed in the US, there is no need for investors to risk all on one or two stocks. You can diversify and still prosper.
In software we look for younger companies, with proven products, seeing very high growth as businesses invest in their digital capabilities. Varonis, a cyber security company, has a trick of logging into a company’s intranet and showing the management how easy it is for employees to access information they have no right to see. Its sales grew 15 per cent last year and are expected to grow by 22 per cent in 2021.
Stocks like this are difficult to value, as cash profits are only starting to come through, but by the time you have read about their applications and technology you know a bit more about the speed of change in the world of data.
In some ways the most striking example of new technology last year was the speed and success with which five companies developed vaccines for Covid-19. In the case of Pfizer and Moderna, they used mRNA technology that teaches our cells to make the Covid spike protein and thus trigger an immune response, rather than the traditional route of injecting deactivated virus.
The companies that discovered the vaccines have generally offered to make them for no profit, but they may benefit if we move to annual mass vaccinations of populations. Also, this method of designing vaccines has been shown to be adaptable as viruses mutate and may be applicable to other diseases.
Oddly, a number of these companies have performed rather poorly as markets worry that governments need to reduce the profit margins of “big pharma”. For instance, Pfizer — around a tenth the size of Microsoft — currently trades on just over 10 times this year’s earnings and has a yield of 4.4 per cent — hardly the “expensive” US market many describe.
Beyond this, the importance of testing and being able to decode genomes — of viruses as well as people — makes the prospects for Illumina look bright. It is the world leader in sequencing equipment.
Lastly, PerkinElmer had an exceptional year, delivering mass testing for the virus. Some investors are selling shares now, bored that this growth spurt is behind them. However, testing may continue rather longer or even more frequently as we return to the office and school. Even when Covid testing ends, the future of public health suggests we may all rely on more testing for diagnoses beyond the walls of hospitals.
The US economy may also recover more vigorously than others, led by falling unemployment and President Joe Biden’s stimulus plans, which principally put cash in the hands of those more likely to spend it. With greater openness to immigration and a fertility rate of 1.78 births per female, compared with 1.62 in Europe, the US population continues to grow steadily.
The size of the millennial population in the US is rather larger than that in Europe, and this group, now aged 21 to 40, tends to drive consumer booms, borrowing to set up home.
They say America is big — well, its stock market is certainly big, broad and diverse. This year should see the US economy recover well, even without Biden’s $1.9tn stimulus spending. With that plan well deployed and as long as any inflationary impact proves modest, America should prove a profitable hunting ground for the astute investor.
Simon Edelsten is co-manager of the Artemis Global Select Fund and the Mid Wynd International Investment Trust.
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