Mohsin Bukhari, head of investments at Carrington Investments gives us insight as to why they are reducing exposure to ‘vulnerable’ US equities.
'This year’s negative sentiment has continued in a more pronounced way than we had anticipated, due to ongoing trade tensions and now the US yield curve. We believe we are right to be reducing risk and will continue to do so into the new year.
We think US GDP growth is likely to slow from here, as the effects from the fiscal stimulus will fade, while the Fed continues to hike interest rates. The outcome of the US midterms, with a split in the houses, will limit what president Donald Trump can do on the fiscal front and we therefore think we will not see any further stimulus.
On the corporate front, some US companies have already signalled a weaker earnings outlook as the trade tensions weigh on their activity. Along with slowing GDP growth, we believe we will see lower corporate earnings too over the coming quarters. The message here is that we think US equities are vulnerable and our efforts to reduce risk are focused here.
Japan continues to be geared into the global economy and so while we like the long term story, we feel Japanese equities will come under pressure along with the US over the shorter term and are also reducing our exposure here.
It is a little more encouraging that the Fed has toned down its hawkish stance, with chair Jerome Powell now suggesting we are near the neutral rate. A slowdown or pause in the US hiking cycle is likely to be negative for the US dollar. We have been thinking about this risk for a while and have switched some of our US dollar exposure into currency hedged products. However, there is another more important risk that we have been thinking about; Brexit.
Although the outcome of Brexit continues to be unclear and binary, the chances of a no deal appear to be much smaller than the other potential outcomes, such as some form of a deal being agreed and another referendum. Therefore, the risks are skewed to the upside for sterling. Again, this is a risk we have been thinking about for some time, with a sudden leap in the pound potentially having damaging effects on our portfolios. This has added significant weight to using currency hedged products and our recent switch has looked at reducing our overseas exposure to help mitigate this risk.
It is worth adding that in the event of a sterling rally, we will be looking to switch into UK large caps because they are likely to offer significant value. We will also look to reduce some of our credit exposure in favour of short dated Treasuries.
ETFs continue to feature in our thinking and are gaining traction in our portfolios. Clearly, there are cost benefits to holding them, but I think there could be other benefits too.
The bull market since the financial crisis has been led by growth stocks, since the monetary policy response by central banks has supported their
growth. Naturally, the asset management industry has gravitated towards this investment factor to improve returns and attract flows. However, vanilla ETFs provide a more diverse exposure and are not overly exposed to any particular factor. This was evident during the October sell off, where many active funds underperformed ETFs because growth stocks were the worst hit.
I therefore think that while some active funds could help during the more volatile times ahead, ETFs will continue to have a place in portfolios as the growth bias unwinds.
A last thought is on the so-called smart beta ETF. Technological advancement is accelerating and some of this development is making its way into the quantitative models used with smart beta ETFs.
I still think they are in their infancy and it is only a matter of time before they become increasingly sophisticated. I therefore envisage a future where we end up primarily investing in products that are half way between vanilla ETFs and active funds, something which resembles what we currently call smart beta.'