Warning signals for investors in US stocks

The majority of corporate America has delivered strong quarterly figures. Nevertheless, investors should not ignore individual risks.

The US companies are doing well. Almost all 500 companies of the S&P 500 US stock exchange index have now reported figures for the third quarter. The vast majority of them were able to improve their results and exceeded expectations. On average, pre-tax profit increased by about 37% compared to the previous year and sales was up 16%. Profit was around 15% above expectations, sales around 6%.

Due to global supply chain bottlenecks and a lower employment rate in the US labor market, costs have risen for companies, but according to many companies, demand is so strong that they can easily pass on price increases to consumers. Examples of this are companies such as the hygiene product manufacturer Kimberly-Clark, the logistics companies FedEx and UPS, the car manufacturer General Motors, the consumer goods group Procter & Gamble, the beverage manufacturer Pepsi, the fast food giant McDonald's, the spare parts dealer Autozone, semiconductor manufacturer Qualcomm or the chemical group Dow. Many companies continue to forecast strong figures. The financial service provider PNC states that "the vast majority of our customers want to build inventory and invest more”.

The market is (on a) “high”

For example, the net margins of companies remained at record levels in the third quarter. According to the analyst consensus, they should fall in the last quarter of 2021 and in the first quarter of 2022, but given the continuing margin strength, the estimates can even prove to be too conservative. Also because the latest figures on retail sales and industrial production have been positive. Plus demand still seems strong. It seems that consumers are still sitting at $2.2 trillion in excess savings that accumulated during the pandemic. This could further support the sales growth of companies.

The S&P 500 has risen around 8% to a new high since the beginning of October. The other US indices went in the same direction. According to experts on the street, everything points to a strong holiday season and a year-end rally. There seems to be broad confidence.

So much for the better. Despite the good figures, however, this rally could slowly run out of air. Although profit growth is significantly higher than the average of recent years, the extent of surprise has been the lowest since the beginning of the corona crisis. Unlike before, the estimates for the fourth quarter of 2021 and for profit in 2022 are almost unchanged. Analysts' growth expectations have already reached lofty heights. According to Bank of America, they are at a record high for US companies, higher than during the tech bubble.

However, history shows that in the past two decades, only 20% of companies with long-term high growth expectations have really been able to meet them. According to Ned Davis Research, analysts expect an average of 10% profit growth for US companies, which gives the broad market a price-earnings ratio of over 21. This high valuation is only justified if you note that the real interest rate in the USA remains negative. Therefore, there is no way around stocks for the return-conscious investor.

This environment could be severely affected next year, based on the heated discussion about inflation in the USA. The country is currently experiencing the highest inflation in thirty years. According to the University of Michigan, consumer sentiment has reached a ten-year low. The market expects inflation of 4.9% in 2022. Five-year inflation expectations are at an all-time high of 3.2%.

The market does not currently regard increased inflation as temporary, as the US Federal Reserve repeatedly asserts. According to experts, this makes a faster normalisation of US monetary policy likely and thus also a cooling of the economy. Fed boss Jerome Powell is already holding the door open for a faster end to the securities purchase program. The street expects the Fed to prepare the market for this soon. Deutsche Bank wrote that the first interest rate increase could thus be carried out before June and not as forecasted in July.

Sophisticated selection

Real interest rates will determine the fate of excessively valued shares. Sooner or later, real interest rates would rise and call into question the high valuations of growth stocks in particular. Recently, fund managers have already sold titles from cyclists, tech and industrial companies on a large scale. In the short term, however, the environment for stocks remains attractive in principle, says the private bank Lombard Odier. The fund managers have also accessed US securities as strongly as they did in mid-2013. Also the inflow in energy stocks is greater than ever before.

In view of the demanding environment, investors should now focus on quality companies that have the described pricing power and can further enforce it. Safe values could also be companies that benefit from the accelerated change from fossil to renewable energies in the USA. Perhaps titles in the aviation, automotive, banking, energy, leisure, media, entertainment and telecom sectors. On the other hand, companies in the consumer goods, food, health, industry, retail and technology sectors should be considered with caution. Perhaps also focus on the small-capitalised US stocks in the Russell 2000 index.

In any case, investors still have enough time to prepare for more uncomfortable phases. Because the US companies are still running in high gear.