US equity feeding frenzy wanes as end of cycle looms

Fund buyers wishing to increase US weighting has dipped

Despite the S&P 500 hitting fresh highs in April this year, UK fund buyers remain circumspect on the prospects for US equities.

According to data from Last Word Research, in the past 12 months, from Q2 ’18 to Q2 ’19, the percentage of UK fund buyers wanting to decrease their weighting to the US has remained the same at 32%, while those wishing to hold has remained at 51%.

Over the same time period those investors wishing to increase their US weighting has dipped by two percentage points, from 14% to 12%.

Concentration concerns

One fund buyer who has long been cautious on the US is Iboss. Chris Rush, senior investment analyst at the firm, argues the most prominent bias of the last decade has been the popularity of US equities. The trend hit fever pitch in April when the S&P 500 touched record- breaking heights.

“Our medium-risk products have allocations to the US of 15-18%,” he says. “Considering the US makes almost one-sixth of these portfolios, it may come as a surprise that they are considerably underweight in the region relative to the peer group.

“The IA Mixed Investment 40-85% Shares sector – the benchmark for our medium-risk products – has seen US assets over the last 10 years increase from, on average, 11% to 24% of a balanced portfolio. This is particularly concerning for medium-risk investors who expect a more balanced and diversified approach but have, perhaps unwittingly, become more concentrated, particularly within their equity allocation.”

Rush says while Iboss portfolios are underweight relative to the benchmark, the firm still invests a considerable amount within US assets, but its allocation is closer to the long-run average.

“Essentially, we remain cautious,” he says. “However, it is not only the herding effect that leaves us with this view; as we have argued for some time it is because US equities look particularly expensive relative to history.”

While admitting the Cyclically Adjusted Price Earnings ratio is notoriously unreliable for forecasting market corrections, Rush notes it is “perversely” reliable as an indicator of future returns.

“No matter what your opinion, the outlook appears to be poor. If history is any guide at all, as markets hit new records, that outlook gets progressively poorer,” he says.

Stuck in neutral

Adrian Lowcock, head of personal investing at Willis Owen, says his firm has adopted a neutral position in the US for some time and has continued this stance throughout 2019.

According to Lowcock, the tax cuts that boosted earnings for corporate US have now worked their way through the system and have slowed down this year. Meanwhile, the interest rate rises of 2018 continue to have an impact on the economy.

“US valuations remain elevated throughout all of this, although not all areas are expensive and there are still value opportunities in the market,” he says. “The longer the US/Chinese trade war continues, the greater the impact it will have on sentiment and the harder it is to reverse things.”

On the positive side, Lowcock notes the Federal Reserve remains focused on the economy. In its efforts to avoid a recession or economic risk it is quick to jump on any issue.

“As such, interest rates rises have been paused with expectations of a cut, and therefore the US dollar rally has also slowed. This should be good news for the markets and the economy,” he says.

“We expect the economic and corporate data to remain under pressure for the second quarter. We will see some recovery in the latter half of 2019 but this will be overshadowed by the political risks that continue to weigh on global growth.

“While a recession might be avoided in 2019, it is hard to ignore the fact that the economic cycle is long in the tooth.”

The passive road

When it comes to investing in the US many investors decide to go down the passive route, given how efficient the stockmarket is perceived to be.

“It might be a cliché but the US market is the one where I come closest to using passive funds,” says Ben Yearsley, a director at Shore Financial Planning. “This is for the simple reason that active management struggles to beat the most covered and liquid global equity market. If active is not the best, why pay the fees?”

The flip side of this, adds Yearsley, is that the market is now so dominated by large technology companies that owning passive is a much bigger risk than in the past, especially as much of the tech space is very expensive.

“Half of the top 10 names in the S&P 500 are tech, making up almost 20% of the index,” he says.

“This is eerily similar to the late-90s when Vodafone dominated the FTSE 100. As much as I like tech, it makes me nervous, meaning I end up with active funds, albeit with a high technology weighting.”

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