Navigating the outlook for U.S. equities

After strong first-quarter earnings in many sectors, investors are considering the market’s potential for longer-term growth during the post-pandemic recovery.

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“General speaking, earning results are past expectations, and forward commentaries are supportive of the idea that the economy is going to continue to rebound,” said Jeff Agne, managing director at New York–based Rothschild Asset Management and co-portfolio manager of the firm’s large-cap value products.

“Most companies are seeing sequential improvements in demand, and, if anything, the lack of inventory in some industries is preventing numbers from being even higher.”

Growth expectations for the S&P 500 in 2022 are about 10% above 2021 earnings estimates and 28% above 2019 earnings, said Agne, whose firm manages the Renaissance U.S. Equity Value Fund.

“Those are some pretty healthy growth rates, and it’s possible we’ll even see continued positive revisions to numbers in both 2021 and 2022,” he said.

At the same time, “there’s already a lot of good news baked into stocks,” he said, and there are other challenges ahead for investors.

In the coming quarters, volatility will be a factor for market performance. “While there are many signs the economy is healing, we do expect to hit some bumps along the way,” Agne said.

For example, while U.S. jobs data in May improved over April, companies are struggling to find workers as labour force participation drops. In Canada, jobs were lost in both April and May.

Pandemic-related uncertainty and rising inflation also weigh on markets. Following stronger inflation data in recent months, last week the Federal Reserve raised its inflation forecast for 2021 and signalled that it would raise interest rates in 2023 instead of 2024. In response, the S&P 500 dropped 1.9% last week, and the S&P/TSX composite dropped 0.7%.

Of note was the drop in value stocks, which had rallied in recent months on expectations of a strong recovery. They may still have room to run, however. The Russell 1000 Value index comprises a large proportion of sectors that benefit from the continuation of the reopening trade and higher interest rates, such as financials, industrials and energy, Agne said.

U.S. policy also adds to market uncertainty.

“We’re just a few months into a new presidential administration, and that can certainly introduce new unknowns into the market,” Agne said. “If we take the corporate tax rate, for example, Democrats are pushing for a rate in the high 20s.”

Other ongoing issues south of the border include the infrastructure bill and budget pressures, which could impact various sectors from energy to defence, Agne said.

Overall, he continues to look for names with upside to earnings estimates and attractive valuations relative to peers.

One stock he remains constructive on is Illinois-based pharmaceutical company AbbVie, which has a market capitalization of about US$200 billion. It has dominant franchises in various markets related to certain cancers, pharmaceutical aesthetics like Botox, and inflammation.

AbbVie’s big revenue generator is Humira, an antibody that treats rheumatoid arthritis. Though the company’s patent for Humira is set to expire in 2023, new products may help offset lost revenue.

“As these new products become a bigger part of the revenue mix of the company, we think that warrants a higher PE multiple on the stock,” Agne said.

Agne said he also likes AbbVie’s cash-flow profile and its commitment to continue to grow its dividend, which yields “an attractive 4.5%.”

He recently sold his position in New York–based Discovery Communications after the shares rerated following the introduction of streaming service Discovery+ and the recovery in TV advertising.

“We felt the stock was fairly valued and that enthusiasm for the company’s Discovery+ offering was adequately reflected in expectation,” Agne said.

The firm also sold its stock in Atlanta, Ga.–based PulteGroup, a leading U.S. homebuilder, after shares outperformed the market and the consumer discretionary sector over the last year. Significant price appreciation and the risk of rising interest rates could dampen housing demand.

“It’s hard to see market conditions getting better from what could be one of the strongest backdrops ever for U.S. housing,” Agne said.

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