EMs do well during coordinated global recoveries: Savita Subramanian

The US corporate sector has several advantages that have allowed companies to outperform many other global regions, Savita Subramanian, Head of US Equity & Quantitative Strategy, BofA Securities, said

The US market has been the best-performing globally over the past one year. SAVITA SUBRAMANIAN, head of US equity and quantitative strategy, BofA Securities, spells out the factors underpinning a strong US equity market and possible headwinds and tailwinds, going ahead. In an interview with Samie Modak in Mumbai, Subramanian says high valuations suggest low to mid-single digit returns over the next 10 years. Edited excerpts:

US equities have been best-performing globally. Why is the US market doing so well vis-à-vis other global markets?

The US corporate sector has several advantages that have allowed companies to outperform many other global regions. Firstly, most corporations locked in fixed rate corporate debt at low rates after the financial crisis. Secondly, corporations engaged in quick cost-cutting measures in 2023, with chunkier strategic layoffs ring-fenced to tech and other white-collar jobs for which capacity needed to be rationalised. Thirdly, the risks around low-quality lending do not reside on large regulated bank balance sheets, but are more prevalent in shadow lending (private equity and credit). Also, the S&P 500 has become higher quality by attrition. In 2022 and 2023, twice as many companies dropped from the S&P 500 to the Russell 2000. Lastly, the lion’s share of tech, artificial intelligence (AI) and venture capital, reside in the US. Thus, US corporates are in a ‘pole position’ when it comes to leading innovation like generative-AI and anti-obesity medication. At a more macro level, the US economy is potentially more insulated than other regions for two reasons— the dollar remains the reserve currency, and today there is not a single alternative. The US is now energy independent and is thus less susceptible to oil price volatility, which has been a key issue amid geopolitical risks and supply constraints.

Will the US continue to outperform emerging markets (EMs)?

Emerging markets (EMs) tend to enjoy higher growth than developed economies during coordinated global recoveries. Thus, we believe that select EM equity markets can outperform the US in the advent of a coordinated global recovery. We are starting to see signs of a global recovery in leading economic indicators.

What are some of the headwinds that the US markets face?

The S&P 500 valuations are not particularly attractive and suggest low to mid-single digit returns over the next 10 years. This is against higher returns we have enjoyed over the last 10 years. Investors have grown increasingly bullish on US equities, relative to other regions and asset classes, and sentiment has moved from abject bearishness to cautious optimism — and outright bullishness on themes like AI. The end may be nearer than it was in early 2023 when investors were expecting a hard landing. Also, election uncertainty will likely drive volatility during the second half. The VIX, a gauge of S&P 500 market volatility, typically increased by about 25 per cent during presidential election years, and stocks tend to fare poorly amid uncertainty. Also, the two tailwinds for margins and earnings over the last two decades of globalisation and free capital translating into big share buybacks are likely to ebb rather than increase from here. Finally, the potential unintended consequences from the massive hiking cycle on the private equity and credit markets spilling into the public markets.

What are some of the key tailwinds?

Elections can be a big tailwind. Stocks typically rally after election day amid the removal of the uncertainty overhang. Moreover, both President Joe Biden and Donald Trump agree on two growth-positive themes — move intellectual property (IP) out of China and back to the US; move jobs and manufacturing back to the North American corridor. The US has already weaned itself away from China growth — 50 per cent of economic activity conducted with China prior to 2018 has been replaced by Mexico or Canada. AI, robotics and other technological advances should translate into productivity growth and labour efficiency, thus keeping margins stable and pushing multiples higher. This comes as companies replace risky labour with more stable, predictable and repeatable processes.

Do you think the US rally can broaden from here?

The US market has been driven by a few stocks with the strongest earnings. But from now through year end, the differential in returns between mega-cap technology stocks and the average company in the S&P 500 begins to narrow meaningfully. This suggests that stock leadership should shift to other areas besides mega-cap tech.

What is your take on Indian equities? Are the premium valuations justified?

India’s valuation premium is likely based on transparency and growth. But India has its unique advantages such as stronger demographic trends, plus a much longer runway for consumption growth in the middle class cohort. It is likely that we will be more bullish on India than we are on US equity returns for the remainder of the year. Our year-end forecast for the S&P 500 is 5,400, which is just a few percentage points away.

Do AI-related stocks still offer big investment opportunities? Which are some of the other exciting investment themes?

AI is a nascent theme and so far the key beneficiaries have been capex takers such as chipmakers, software and new media. More recently, it is power and grid plays in utilities and industrials. But from here, we see AI implementation impacting broader parts of the equity market. Labour-intensive sectors like IT services, financial, business and consumer services companies could become more labour light. In our quantitative work, we have found that labour-light companies almost always outperform their labour-intensive counterparts.