Tapping into the bond attraction
This article first appeared on Octomembers.com on 17th November 2022 “How do you prepare for the...
Having been the poster child of global stock markets for the past decade, the US stock market has had a shocking 2022 so far. April was only the fourth month in nearly 50 years that the S&P 500 fell more than 5%*. What’s more, US treasuries simultaneously fell around 2%*.
“For US equities it marked the worst 4-month start of year period since 1939 (and third worst on record), while for US 10-year bonds it was the worst total return since 1788, just before George Washington’s presidency,” said Hugh Sergeant, manager of ES R&M UK Recovery fund.
The situation has not improved, and, in June, headline inflation topped 8%, while the US stock market entered bear market territory, having fallen more than 20% from its peak.
Our Elite Rated and Radar US equity funds have not been immune to the fall out, although some have held up better than others.
JPM US Equity Income, for example, has fallen just 1.62% year to date, while the growth-orientated Baillie Gifford American – the best performing fund of 2019 and 2020 – has seen its value more than halve.
|Fund||Percentage returns year to date*|
|JPM US Equity Income||-1.62%|
|Schroder US Mid Cap||-10.32%|
|Artemis US Extended Alpha||-12.03%|
|Premier Miton US Opportunities||-12.65%|
|Brown Advisory US Flexible Equity||-15.16%|
|T. Rowe Price US Smaller Companies Equity||-16.47%|
|AXA Framlington American Growth||-20.35%|
|Artemis US Smaller Companies||-24.15%|
|T. Rowe Price US Large Cap Growth Equity||-25.93%|
|Premier Miton US Smaller Companies||-27.57%|
|FTF Martin Currie US Unconstrained||-29.11%|
|Baillie Gifford American||-51.06%|
So, should investors cut their losses in the world’s largest economy, or is now the time to buy?
Bob Kaynor, manager of Schroder US Mid Cap fund, says that whereas the S&P 500 has delivered the best returns in recent years, driven by a small number of companies, there is a strong case for diversifying US equity exposure more into small and mid-caps looking ahead. “They offer better earnings growth than large caps at some of the largest valuation discounts in history,” he said.
However, James Yardley, FundCalibre’s senior research analyst prefers US large caps at the moment. “I’m expecting a recession in the US,” he said. “The high price of petrol and inflation is starting to really depress US consumer sentiment. This will hit the domestic economy and be more negative for US small caps.
“I prefer the cash generative growth mega caps which are starting to look quite cheap. That said, we still really like US small caps for the long term.”
With yields now at 3%, US 10-year treasuries are looking more attractive.
“On the one hand, the US 10-year is a dream asset in the portfolio as it has a negative correlation to equities at times of extreme stress,” said James Yardley. “But with inflation over 8% and yields at 3%, that is a huge differential.
“If you are buying 10-year treasuries today you have to believe that inflation is going to come down significantly, or you risk further losses. Do steep Fed rate rises kill growth and inflation and send us into recession in which case 10-year yields are likely to fall heavily as the Fed reverses course? Or does the combination of quantitative tightening, a tight labour market, higher rates and inflation send US 10-year yields soaring north of 5%? I’m in the camp that starts to build the US ten-year and reduces high yield exposure in case of recession.”
Mark Holman, a portfolio manager at TwentyFour Asset Management, is of a similar mind. “The world’s favourite safe haven asset looks to suddenly be back in fashion, and that is because for some, recession is now looking more likely and less far away than it did a few weeks ago.
“We think building a position in 10-year US treasuries is now a serious consideration for bondholders, as is gradually increasing credit quality and focusing on shorter dated bonds in the coming months in order to try to get maximum benefit from the higher yields on offer in fixed income today.”
“When the rate hikes stop, and investors can once again value risk with some certainty, cheaper asset prices across credit and sovereign bond markets alike will represent an incredible opportunity set for investors seeking attractive returns,” said Dickie Hodges, manager of Nomura Global Dynamic Bond fund. “The opportunity is coming, and we are ready to pounce on it. We just need to remain patient for now. But 2023 and 2024 could be good for fixed income markets.”
Maneesh Bajaj, manager of Brown Advisory US Flexible Equity, agrees: “Due to unprecedented inflation, Ukraine war and the aftershocks of the pandemic, investors across various financial instruments (stocks and bonds) are more skittish today, driving up the risk premiums.
“It is difficult to gauge where the long-term interest rates will finally settle, which will be the ultimate arbiter of equity valuations and returns. But despite the uncertainty, our view remains that over the longer-term, U.S. equity markets are the right bet for capital appreciation.”