The bright spots for investors in the year ahead

Investors had an exciting April and May this year, when America’s S&P 500 stock market index rose 19.5%. But June was a quiet month, with the index losing 1%. The third quarter is likely to be similarly quiet as earnings catch up with the market, and the fourth quarter might be too. Market analyst Ed Yardeni is still targeting a year-end level of 8,250, representing a forward multiple of 22 on his forecast of $375 of earnings per share in 2027.

That earnings forecast is well below the consensus, now standing above $400, but leaves room for continued growth thereafter. If the index makes no further progress this year, it will have de-rated to a forward multiple of 20, which would be reasonable even if ten-year US Treasury yields rose to 5% and would leave room for a further market advance in 2027.

Opportunities for investors in US stocks

The end-of-the-world crowd continue to believe the US stock market is overvalued. Dire warnings focus on the supposed bubble in AI-related stocks, including semiconductors. Christopher Watling at Longview Economics points out that food retailers Costco and Walmart trade on prospective multiples of 40, Caterpillar on 35 and GE Aerospace on 47. These multiples certainly look too high. This is definitely an argument for caution from investors and for modest expectations, but there are pockets of opportunity.

Discounts on investment trusts should continue to fall as rising interest in investment meets a net shrinkage of capital. Particularly attractive are the private equity, infrastructure and property sub-sectors, where generous discounts to net asset value and often attractive yields combine with an improving outlook.

The increase in flotations is giving private-equity funds an exit, freeing capital for new deals. Rising construction costs have increased the replacement cost of existing buildings, while rental demand is picking up. Infrastructure funds continue to deliver and even renewable energy is on an uptrend, thanks to asset sales, share buybacks and takeovers.

Among trusts investing in equities, discounts are often low, but those of RIT Capital, Hansa Trust and Pershing Square have scope to fall. The healthcare sector, notably Worldwide Healthcare Trust, is picking up as, at last, may the performance of Finsbury Growth Trust. Nervousness about the technology sector means that the two specialists, Allianz Technology and Polar Capital, trade on near-0% discounts, while the lagging performance of small caps has left attractive discounts in most regions.

Japanese government bonds look good value

The UK government would love people to buy more of the bonds they are issuing in huge volume, but market analyst Charles Gave points instead to the good value of Japanese government bonds, trading on a yield close to 3% for ten years and more than 4% for 30 years. As he argues, a structural growth rate of nominal GDP of 2.4% makes these yields attractive and the devaluation of the yen has made Japan highly competitive. A high national debt is matched by high domestic savings and the hugely successful government policy of investing in equities when the market was much lower.

The cheapness of the yen offers the prospect of currency gain, but for equities there is a risk that a rising yen would slow earnings growth. Japan still looks reasonable value, but a 30% advance in the last year is enough for now. Emerging markets, led by exposure to the Far Eastern technology giants, are up around 50%, which also looks far enough. The UK and Europe are up “only” 20% and appear good value, but are bedevilled by slow growth.

Cautiously bullish on the oil and gas sector

The pause in America’s Gulf war has led to the oil price plummeting again, and the oil and gas sector losing a good deal of the first quarter’s gain. The war has been far from a triumph for Iran. It is militarily crippled, diplomatically isolated and economically savaged, with its hope for regional hegemony shattered. The closure of the Strait of Hormuz led to the oil price going above $100 a barrel, but not to the $150-$200 that the doomsayers predicted.

As oil and gas increasingly bypass the strait, alternative sources are opened up and the rest of the world follows China in stock-building, future closures of the strait will be even less effective.

This may not be bullish for the prices of oil and gas, but it is bullish for the sector. Governments will want to encourage domestic supply and energy self-sufficiency. This means hands off the sector in terms of taxation, licensing and regulation. Governments will be equally keen to encourage the replacement of fossil fuels with renewable energy, as the Chinese have done. Buying into the recent sector setback looks an attractive option.

The best strategy for the rest of the year is to continue to ignore the bears and use the period of consolidation in markets to invest for the next market advance. That is far easier than chasing it when it again has upward momentum.

This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.