In September, the US Federal Reserve (Fed) surprised many as it announced the first cut to US rates for four years – lowering its benchmark interest rate by 50bps to 4.75-5% target range.
With such a pivotal move for the US economy, we’ve been talking to some of the leading investment managers and strategists to gauge their views on what this means for the markets, for asset allocation and stock selection. With the next Fed decision due on 7th November – just after the Presidential election – and much discussion about a slowing US economy, we’re grateful to all the following investment strategists and manager for sharing their views with us as follows:
According to Neil Birrell, Chief Investment Officer and Lead Manager, Premier Miton Diversified Fund Range, there are opportunities within certain sectors like small caps as he comments:
“The only questions on Fed policy change were; when would it start and how fast would rates fall? It started later than expected and rates may well fall rapidly now, with the Fed having plenty of room for manoeuvre. Given the trend was predictable it probably doesn’t mean much change to the outlook for regions and sectors, although we are likely to get a concentrated reaction in markets. That could well play out in interest rate sensitive parts of the US equity market; cyclicals should benefit and other sectors which had already been doing well, could get a turbo-charge. An example of that could be the energy sector; the demand for electricity, in particular, has been surging on the back of electrification and AI datacentres expansion; given these companies are interest rate sensitive, it’s an interesting niche area that’s not on many radars. More generally in the US, small caps look like the place to be on valuation grounds and as well as growth prospects.
“Internationally, small caps, overall, look attractive, in absolute terms and relative to large caps. They tend to outperform when economies are expanding, which usually follows rate cuts and the ECB and Bank of England are in the same phase as the Fed, although maybe not as aggressive in policy moves.
“Whilst much of the bond market has moved to reflect rate expectations there is plenty of scope within equity markets to find beneficiaries, although being selective will be key. Other asset classes should benefit, with real estate being a good example.”
David Lewis, Investment Manager, in the Independent Funds/Merlin team at Jupiter said:
“We have now entered a rate-cutting cycle for the major Western central banks, which has the potential to bring about a change in the investment backdrop. We have been in a relatively rare situation where the yield on longer dated bonds has been lower than for shorter dated bonds. This is unusual as one would usually expect higher returns for taking greater uncertainty in tying up capital for longer. This dynamic has recently reversed and, in the past, this change has often presaged a recession in short order. Recently this has been known as the risk of a hard landing. However, it is also arguable that this normalisation of bond markets can simply be a by-product of bond yields incorporating the likelihood of interest rate cuts, which can help us achieve a soft landing, essentially preventing a recession and creating a path to continued growth.
“Of these two potential pathways we are favouring the latter, leading us to view equities as attractive in aggregate, but we particularly like UK and Japanese equities, which we see as two of the best value opportunities in the markets as they are both somewhat cyclically exposed and could benefit from lower rates and a soft landing. In the fixed income markets, we see bonds as generally good value, offering inflation-beating yields across the board with the potential to benefit from capital appreciation as yields move down in tandem with falling interest rates, making them preferable to cash.”
Matt Bullock, EMEA Head of Portfolio Construction and Strategy at Janus Henderson Investors, is also seeing investment opportunities in the market although he does warn of the need to take care around risk as he comments:
“Overall, we are currently in a good environment for equity investing, however there is a need to be particularly careful around risk.
“We have seen a tendency in the market to reward large cap growth-oriented stocks, however, we believe there are opportunities for investors who are willing to broaden out and blend these exposures with other ‘less loved’ areas.
“As we move into the rate-cutting stage of the cycle, now is the time to look for opportunities in the more cyclical areas of the market.”
When it comes to equities in particular, Bullock says: “We are seeing increasing opportunities in the following areas. Firstly, small/mid cap stocks. These have tended to be very cyclical performers and are attractively valued. The market has for some time shunned small-cap stocks in favour of larger, more established companies. Yet, as we move further into the cycle of global interest rate cuts, stronger companies in the small-cap sector stand to benefit significantly. Nonetheless, in an environment where the cost of capital has risen, the ability to discern the future winners from the losers within the small cap space is ever-more crucial. Careful analysis of both valuation and earnings growth is critical to maximise the potential within small cap investments. Tapping into the knowledge and analysis of small cap managers could be a way for investors to find more wheat than chaff.”
“Then there are European Equities: The European market has gone through a process of renewal over the past decade or so, to become more concentrated at the larger-cap end, and with significant changes across industries. Lower growth, and generally domestically focused businesses have been replaced by more globally exposed firms. European companies are finally benefitting from the vast capital expenditure of ‘big tech’ as we see this multi-year AI theme continue to develop. This covers the fundamental ‘enablers’, like semiconductor manufacturers, as well as data centre development, storage, and infrastructure development.”
“Finally in thematic equities, such as healthcare, property, technology, and sustainable equities, these possess distinct characteristics and drivers of return, which can be blended to optimise portfolio composition for a range of outcomes. Property, in particular, stands to benefit from rate cuts and the outlook has become more positive. Underlying property valuations have stabilised and listed real estate continues to trade at attractive entry point levels. Moreover, we continually see that active management provides the insight, experience, and depth of expertise needed to identify winners and losers, to create a market-resilient portfolio.”
Going on to share his views on the outlook for fixed income, Bullock said:
“Even with the 50 basis points cut in the US, yields are still elevated compared to recent history, thus providing investors with attractive levels of income along with potential capital appreciation.
“Investors may be able to capitalise on opportunities across the yield curve whether that be relatively high yields on short-term maturities or potentially adding greater risk to target higher total returns with longer maturities. However, it’s important to consider what has already been priced into markets.
“Securitised assets, we believe, are attractively priced where there is the potential to lock in higher yields with only incremental increases in risk. Collateralised loan obligations (CLOs) could be quite interesting as AAA CLOs have historically paid a higher credit spread than short duration Investment Grade.”
Benoit Anne, Managing Director – Investment Solutions Group of MFS Investment Management, said:
“Words are as loud as actions. The Fed rate cut in September was highly significant. Not only because of the size of the rate adjustment but more importantly because of the words that accompanied it. Essentially, the Fed has argued that the soft-landing scenario is still firmly their baseline. In other words, if we believe the Fed, it is goldilocks time. Inflation has been forecasted lower, the US growth outlook remains robust, and the unemployment rate will only tick up marginally in the period ahead. The overall Fed communication around the rate decision was well managed, and there was no mishap at the press conference. So what is next? On the policy side, the Fed appears to have expressed a preference for a faster convergence to neutral, though the pace from here remains uncertain. Away from monetary policy, we believe that the macro backdrop remains relatively supportive for both fixed income and risky assets. It is worth noting that US financial conditions—as illustrated by the Goldman Sachs index—are now as loose as they have been since early March 2022, as a positive sign for global investor sentiment. Looking at the market response following the Fed cut, the most important signal we have observed is that credit spreads have tightened further, both in the US and in Europe, as an indication that the macro credit fundamentals remain constructive. Finally, the initial aggressive policy easing in the US may put some downward pressures on the USD, with positive implications for other developed markets and emerging market assets.”
Sharing her views on whether the Fed can avoid a US recession, Invesco’s Chief Global Market Strategist, Kristina Hooper, believes it can, commenting: “There are legitimate concerns about recession. Monetary policy was very restrictive for some time. FedEx, one of those bellwether stocks that can give us insight into the state of the economy, recently guided expectations downward. And the S&P Global PMI Survey for the US shows a manufacturing sector that has moved deeper into contraction.
“However, I’m in the camp that believes that the US will avoid a recession. The Citigroup US Economic Surprise Index, while still in negative territory, has risen materially since late August. And credit spreads are suggesting that a recession is not in the offing. The ICE Bank of America US High Yield Option-Adjusted Spread hit a recent peak of 3.93% on Aug. 5. Since Sept. 10, spreads have fallen significantly, down to 3.1% on Sept. 19. This is a very low level relative to history. It tells me that the Fed is not far behind the curve and that its 50 basis point cut has increased confidence that the US should avoid a recession. And the S&P Global US Services PMI reading remains strong.”
Rupert Thompson, IBOSS Chief Economist, part of Kingswood Group highlights some of the relative value opportunities being offered by the UK and emerging markets given the recent market moves as he comments: “As ever, the Fed’s commentary surrounding its move was almost as important as the cut itself. The Fed usually only cuts rates by as much as 0.5% when it is staring a recession in the face and Chair Powell did his best to argue that this was not the case this time. He emphasised that the economy remains strong and the cut was just a reflection of greater confidence in inflation returning to 2% and the desire to head off any further weakening in the labour market.
“The Fed lowered its projection for interest rates by 0.75% for both the end of this year and next year. It now sees rates falling, from their current 4.75-5.0% to 4.4% by year-end and to 3.4% by end-2025. That said, it continued to emphasise the uncertainty over the speed and extent of the forthcoming decline.
“The price-earnings ratio of the US is once again as much as 60% higher than other markets. With doubts now emerging over whether the massive AI-related investments of the Magnificent Seven will be as profitable as they hope, such high valuations are becoming more questionable. The UK and quite a few emerging markets, by contrast, remain downright cheap and look attractive.”
Chris Clothier, Co-CIO, CG Asset Management, commented:
“There are signs that the US economy is slowing sharply and the chances of a recession in the US over the next 12-18 months have increased significantly. There are several indicators that are supportive of this view as follows:
- Savings rate – the US savings rate is low, implying that lower-income consumers are struggling to make ends meet.
- Unsecured credit – delinquencies are rising, credit card and auto delinquency are now at levels not seen since 2011.
- Labour market – the labour market is slowing which inter alia has resulted in the Sahm Rule being triggered. Hiring rates are at levels consistent with a recession.
- Capex orders – year-on-year capex orders are flat in nominal terms.
- Dis-inversion of the yield curve.
“This last point is slightly counterintuitive, after all the conventional wisdom is that an inverted yield curve is a harbinger of recession. Whilst true, the picture is slightly more complex: an inverted yield curve is a signal that the bond market believes that a recession is likely in the short to medium term because it implies that interest rates will be lower after 2 years than for the next two years.
“However, dis-inversion means that the bond market thinks the recession is actually here, and that the Fed will have to cut rates aggressively, leading to lower interest rates in the near term compared to the longer term. This pattern of inversion => dis-inversion => recession has occurred before each of the last three US recessions.
“We think that the bond market is only half right: the slowing economy means that rate cuts will be warranted. However, we believe inflation will prove stickier than the market expects, which will reduce the Fed’s latitude to act. Conversely, the equity market is looking increasingly out of sync with the bond market. The S&P 500 is at record highs, valued at 24x current year earnings, and pencilling in 14% earnings growth for next year.
“We are siding with the bond market and therefore, at the margin, trimming risk exposure in our funds.”
