What next for the US? Three fund ideas

Is it possible to predict what America's stock market will do this year and beyond? There is certainly no shortage of imponderables, from the president’s foreign policy to the likely financial returns on the huge sums being poured into artificial intelligence by US technology companies. It seems safest to steer clear of crystal balls and instead identify some key influences, positive and negative, on the American economy and stock market. Then we’ll outline what strikes us as a prudent approach to investing in Wall Street.

• Get updates on markets, ISA funds, pension saving and much more

Reasons for optimism about the US

• America remains a very dynamic economy, as its rapid turning of AI from intriguing technology niche into potentially transformative driver of a ‘fourth industrial revolution’ shows
• There is a good chance that interest rates will continue to fall, especially as the severe rise in inflation predicted as a consequence of higher tariffs has failed to materialise. All else being equal, lower rates are good for the stock market: they put more money into consumers’ pockets, they cut businesses’ borrowing costs and so make them more profitable, and they make competing assets such as bonds and cash less attractive
• Oil prices are low and may even fall further. Lower crude prices help to keep inflation in check, which in turn is good for interest rates. They also boost consumption as consumers spend less on energy and they help corporate profits by cutting costs
• Corporate earnings growth is expected to broaden out beyond the familiar beneficiaries among the AI giants and spread to companies lower down the market value scale, Fidelity’s Tom Stevenson said in his recent Investment Outlook.

Reasons for caution

• Stock market valuations are stretched (see below) and it could be argued that American shares are ‘priced for perfection’. Some investors are alert for any sign that those vast AI investments may fail to produce the expected payback
• Government policy remains unpredictable. Intervention in countries such as Iran and Greenland could have unforeseen consequences, especially if a new trade war results over Greenland. Markets have already reacted but could take greater fright if the standoff remains unresolved.
• The administration’s fight with the central bank, the Federal Reserve, could unnerve bond investors and lead to higher market borrowing costs, which as we said above tend to hold back the stock market
• The dollar has been volatile over the past year or so. Any further weakening in the US currency will offset any gains (or amplify any losses) made by overseas investors on US shares.

Overall, Tom Stevenson gave the American stock market a ‘neutral’ rating in his Outlook. ‘The base case for US equities is a continuing but volatile bull market,’ he said. ‘The biggest risks centre on the US’s high starting valuation.’

How expensive are US shares?

They are certainly expensive by historical standards. The current price-to-earnings ratio of the S&P 500 index, based on the past year’s earnings, is 28.5, which has been exceeded only a handful of times over the past 20 years. The index’s dividend yield is 1.4%.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. Direct shareholdings should generally form part of a well-diversified portfolio of other investments. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. If you are unsure about the suitability of an investment you should speak to one of  Fidelity’s advisers or an authorised financial adviser of your choice.