Oxford Dictionaries’ 2016 word of the year was “post-truth”. Its definition – circumstances in which objective facts are less influential in shaping opinion than emotion or personal belief – renders it an obvious choice for the politically charged year that was.
For investors, however, the pertinent question is how facts versus sentiment will influence markets in the year ahead. When it comes to the US, the facts are as follows:
- After a brief wobble, the US stockmarket shook off the slump many expected following a Trump win and has since hit record highs
- The US Federal Reserve expressed its confidence in the economy by raising rates once before Christmas and signaling further rises to come in 2017
- The US dollar has strengthened
- US treasury bond yields have risen
- US equities are still trading around record highs on a Schiller price/earnings basis (which takes into account 10-year average earnings for companies)
- Donald Trump is an untried and untested entity whose policies could go any which way.
Sentiment around the US market currently remains strong. In fact, I would go so far as to say it is stronger post-Trump election. But here we start to introduce a few maybes into the equation. The kind of maybes that seem to be quite influential in shaping investors’ opinion.
One important maybe is Trump’s commitment to lowering corporate taxes. This policy, if enacted, would no doubt be fiscally expansionary, driving US economic growth and inflation.
Similarly, if he allows US companies to repatriate offshore cash with a low tax rate, we could see that cash put to work in mergers and acquisitions, which could again be positive for shareholders.
Another election pledge was to bring manufacturing back “onshore”. Arguably, in this respect, Trump began his term as president even before he had sworn his oath, as the automotive industry will no doubt testify. Let’s not forget, though, trade is a two-way street and protectionist policies could end up cutting the US out of various supply chains in which it currently participates.
Bond yields are also something to watch closely. If growth really does take off, and interest rate rises are faster and higher than expected, we could see 10-year US treasuries get to around 3 per cent. Why would investors buy equities yielding 2 per cent? I have been sounding a cautionary note on US equities for the past year or so and still heed investors to be wary of any potential catalysts for a sell-off. Buying at the peak of the market (if this does turn out to be it) could be punishing to returns.
That said, the S&P 500 delivered total returns of 33 per cent to sterling investors in 2016, despite my reservations (currency assistance aside, it still rose 11 per cent in US dollar terms, too). We may well continue to see upside to US equities in 2017, whether driven by sentiment or fundamentals. Clients without some exposure may find their portfolios fall behind.
Which leaves the question: how best to position in light of these themes? For the first time in around 35 years, we will be investing in a period of rising bond yields and rising inflation this year. It is not that these things are suddenly going to be high but the underlying shift in direction will be important when choosing funds.
Signs of this change had started to show last year and we saw the beginning of a rotation from growth to value stocks over 2016, with bond proxies in particular starting to re-rate. The conditions remain ripe for cyclical and value stocks to outperform, which they may continue to do all year, or until value subsequently becomes too expensive at least.
I like the Brown Advisory US Flexible Equity fund. It has a value bias but will look for growth stocks too. Its managers’ breadth of experience is invaluable in uncertain times. Speaking with them, one has the reassuring feeling of “been there, done that” when it comes to US macro challenges, and the vehicle has the long-term track record to prove it.
I also like Jenny Jones’s Schroder US Mid Cap fund, run out of New York. Its focus on mid-cap stocks could prove rewarding in a market where large-caps are so fully valued. This certainly seemed to be the case in Q4 2016, where the fund comfortably beat the S&P 500, returning around 11.5 per cent to its 9 per cent.
If you want to go down this route, I also consider Hermes US SMID Equity a bit of a hidden gem. It invests even lower on the market cap scale (indeed, it is actually part of the IA North American Smaller Companies sector, not the IA North America sector) but does not take large bets on any particular industries, focusing instead on companies with consistent earnings and low debt, which helps to manage its risk.
Darius McDermott is managing director of FundCalibre