The US continues to be a popular choice for investors. The Investment Association (IA) North America sector drew in £469m in assets in March alone, making it the second most popular sector for ISAs, says Lisa Yang, co-manager of the BlackRock Sustainable American Income Trust plc.
Much of this investment in US equities is flowing into a handful of dominant companies, creating risks for investors. However, at the same time, it is opening investment opportunities elsewhere for investors willing to delve deeper into US markets.
The concentration in the US market is acute, with the Magnificent Seven dominating returns in 2023 and early 2024. This collection of companies – Amazon, Meta, Alphabet, Tesla, Nvidia, Apple and Microsoft - is seen as being in prime position to benefit from the growth of artificial intelligence. These companies accounted for around 60% of the gains in the S&P 500 last year.
This has left valuations looking stretched. While some of the Magnificent Seven are still delivering impressive earnings growth, it is by no means universal. Where companies have disappointed the market’s high expectations, share prices have been hit hard. There may be risks inherent in excessive concentration in just a handful of companies when investing in North America.
Market environment
It is also worth noting that the environment has changed significantly since the start of the year. At the start of the year, financial markets were optimistic about interest rate cuts after the Federal Reserve issued an optimistic statement on rate cuts in 2024. However, since then, inflation has come down, but has remained higher than expected. This means interest rates are likely to stay higher for longer.
This is a different backdrop for markets and one that, in our view, is likely to value a different type of company. We believe predictable and consistent growth, compelling valuations and a growing dividend may become a greater priority for investors.
This does not mean sacrificing growth when investing in the USA, with opportunities in sector such as healthcare, which are supported by good, long-term demographic trends and innovation. The new range of weight loss drugs is an important example. GLP1 drugs are an important breakthrough and create significant growth potential for the sector. There are also promising developments in areas such as oncology and Alzheimer’s. The market has chosen to focus on the growth potential of AI, but that doesn’t mean there isn’t growth to be found elsewhere.
Lower valuations
The narrow focus has left valuations in the broader US market looking more attractive. In the rush to participate in the AI boom, many interesting and resilient companies have been overlooked.
Our analysis shows that projected earnings growth in the remainder of the market is higher than for the Magnificent Seven over the next 12 months. It is good investment practice to diversify your portfolio across a range of sectors and we believe this is particularly important today when investing for both growth and income in US markets.
There are early signs that market leadership is already starting to broaden out as markets adjust to interest rates being higher for longer. As part of this, value, quality and sustainability characteristics may come into favour again. As the US economy continues its recent run of strength, we believe this may signal the future for the US market and investors should be prepared.
