US equities have proven overwhelmingly popular with investors desperate for signs of economic growth. They’ve been the best performers in euro terms since the beginning of the year and their dominance in terms of flows year-to-date is little short of astonishing.
By the end of August, they’d gathered record YTD inflows of nearly €15bn – that’s nearly 70% of all flows and almost more than developed market ETFs in total given the sustained outflows from Europe we saw between February and July.
Nor have these flows been limited to traditional large cap exposures – as the economic cycle has aged, investors have become more selective in their allocations with sector ETFs and, latterly, small- and mid-cap ETFs gaining traction. Sector inflows in fact hit a record €1.6bn YTD by the end of August, with around €900m of that going into technology. But can the run continue?
Net inflows on European ETFs by asset classes so far this year
Sources: Lyxor AM International, Bloomberg. Monthly data in EURM from 1/01/2018 to 31/08/2018
The figures relating to past performances refer to past periods and are not a reliable indicator for future results.
Life in the old bull yet
Despite their strength – and that popularity – we still feel there’s more to come, even at this late stage of the cycle. There’s little doubt Trump’s belated, but unprecedented, fiscal stimulus should foster more inflation at a time the economy is running at or above full capacity. Strong top-line revenues and margin expansion (as well as share buybacks) have bolstered the earnings-per-share outlook for corporates, while recovering capex and the associated upturn in productivity could help mitigate the negative effects of rising wages on profit margins. All of which suggests there’s some further upside ahead. Little wonder investors are still being drawn to the US, despite the unpredictability of the administration on the Hill and the looming mid-terms.
So, for now at least, we’re not put off by seemingly stretched valuations, although they may limit long-term upside potential. We, like many others, have said that before however and the bulls have kept on running…
US sectors: Current price-to-book ratios vs. 20-yr average
Sources: Lyxor AM International, MSCI, ThomsonReuters Datastream. Data as at 30/08/2018
Recent US ISM surveys have reached new cycle highs and the job market has remained strong, suggesting solid growth in the coming months. Outside the US, business survey results such as PMI manufacturing in emerging countries and Europe have dipped on the trade tensions, but they’re still pointing to economic expansion. That could change should the trade war escalate or become more global in nature but we still think a negotiated settlement is ultimately more likely. In truth, a move from sporadic, temporary sell-offs into a lasting bear market requires a more meaningful, cyclical turn down – something we don’t foresee just yet.
Choosing your vehicle
So how should you invest? Choosing the right investment vehicle in most markets is often challenging – except that is, in the US, where active managers really do struggle to beat their benchmarks.
At the end of H1 2018, fewer than 1 in 5 large-cap managers (19%) were giving investors what they paid for. At least that’s better than the 11% that have delivered over the last decade. Small-cap managers fared a little better, with just 1 in 4 having outperformed by the end of H1 but the pattern is clear*. But which passive vehicle should you choose?
Sophisticated investors tend to believe futures are more liquid options than ETFs and cost less overall but the results don’t in our view stack up as often as they’d have you believe.
Taking three of the major US equity markets as our examples, we can see that ETFs were more effective for a broad S&P 500 exposure as well small-caps via the Russell 2000. In contrast, for the NASDAQ 100, futures contracts still win out. When choosing your passively managed investment, you still need to be selective wherever possible.**
* Source: Morningstar & Bloomberg, data from 31/12/2007 to 29/06/2018. **Source: Lyxor International Asset Management, as at August 2018. Detailed methodology and assumptions made available on request. Market conditions may change and have an impact on performance of ETFs and futures. Past performance is no guide to future returns.
You are here
Although every business cycle is different, they do tend to follow a similar pattern. As an economy progresses through the cycle, some sectors naturally perform better than others and vice versa.
Convention has it that when an economic recovery matures, the energy and materials sectors – which are closely tied to raw material prices – tend to do well because inflationary pressures are building and demand is still solid. On the other hand, IT and consumer discretionary stocks tend to suffer because profit margins are being eroded and investors are more wary of luxury spending.
We’re seeing some of this today in the US with the recovery now entering its dotage, but there are specific issues at play helping some sectors defy convention.
Of sectors, sizes and styles
When assessing US equity allocations today, you have to factor in the fallout from the fiscal push. It helped US corporates avoid typical late-cycle issues like slowing earnings growth and a squeeze on profit margins and also ensured a favourable environment for Financials and Technology, through deregulation and tax reform respectively.
Quite naturally, we also favour some more conventional late-cycle calls, including Energy and Healthcare. Energy in particular appeals to us because of its improved corporate fundamentals and the recovery in oil prices.
There are some areas we’d rather avoid too. We’re wary of the Consumer Discretionary sector given company-specific risks and problematic valuations, particularly in e-retailing. We’re also keeping a watchful eye on the most defensive sectors – especially those more sensitive to interest-rate rises including Telecoms, Utilities and Consumer Staples.
Meanwhile, Trump’s tax cuts should still stimulate additional profit growth for smaller companies, many of which benefit from a domestic bias to their business – making them slightly less vulnerable to the ongoing trade disputes.
Choose your index wisely
Precision and selectivity then are the watchwords at this late stage of the cycle. Look to lower cost exposures to make the most of whatever upside remains, tilt towards tech or bet on the specific issues boosting banks with indices like the Morningstar US Large-Mid Cap, the NASDAQ 100 or the S&P 500 Banks. Alternatively, you could seek to add some resilience to your portfolio with quality income or minimum variance strategies.
In contrast, the S&P 500 and MSCI USA look most exposed to those areas we favour least, while the FTSE USA Core Infrastructure comes with a 50%+ allocation to Utilities.
How the indices breakdown vs. our views
Source: Lyxor International Asset Management, Data as at 30/04/2018. For illustrative purposes only. *This sector will be broadened from 24 for S&P indices and end-November for MSCI indices to include stocks from media & internet software & services sectors. At that point MSCI will reclassify the sector as cyclical and we expect the sector composition to move to a growth-tilt from its previous domestic value bias.
Why Lyxor for US equities?
If you still see the US as a land of opportunity, look no further. Our US equity range opens up 14 possible routes to travel, across mainstream and more specific indices from just 0.04%. And, because we’ve been managing ETFs in the region for over 16 years, and run over €8bn* in assets, we may just be the guide you need.
