US equities – Risks skewed to the downside

Key points

• We see the recent rally as short-lived and maintain our cautious stance on equities. With negative earnings growth and expensive valuations currently contrasted by relatively positive sentiment, risks appear to be skewed to the downside for US equities and thus for global equities since the US accounts for over half the market.

• US economic activity appears to be quickening although reluctance to increase capex persists and global trade remains subdued. Political uncertainty remains elevated and equity markets seem relatively complacent about November's presidential elections.

• Valuations are rich on several metrics and the main catalysts, liquidity and earnings, have run their course. Analysts' estimates of 11% earnings growth are ambitious and downward revisions are likely. US earnings growth has now been negative for the last four quarters and the recent rise in unit labour costs does not bode well.

• Market sentiment is tilted towards optimistic while volatility is low. The long US equities trade now appears to be crowded and S&P 500 performance is diverging from quite a few indicators.

• In our asset allocation recommendations, we remain underweight on global equities. Within equities, we are neutral on the US on the back of its defensive appeal and relatively strong macro-economic position.

The rally since late June has been driven by upside surprises in US economic data and investors re-risking post Brexit. We take an all-round approach to evaluate the US equity markets and summarise our views on six key drivers, namely, macro-economics, politics, valuations, earnings, sentiment and technicals. All in all, we see the recent rally as short-lived and that risks appear to be skewed to the downside for US equities...