“It’s not over until it’s over,” SSGA’s head of investments Asia, Kevin Anderson, told FSA in a recent interview.
“Even in December last year, we believed there was still room for equities markets to perform well despite the late stage of the economic cycle, the weaker fiscal support after the boosting effects of Trump’s tax cuts had dissipated, while the US-China trade dispute created uncertainty and before the Fed performed its U-turn on interest rates.”
The firm is broadly positive for its actively-managed strategies – about $2trn of its $2.8trn assets under management are passive – remaining overweight US equities amid significant policy support by the Federal Reserve. But he stressed that investors should maintain a defensive bias as fundamentals disconnect from returns and trade risks mount.
“It is not a full beta play. We prefer defensive stocks, focusing through a strictly bottom-up process on value, quality and consistent earnings,” said Anderson.
Several picks are in the healthcare and hardware technology sectors, although a few are among racier new tech stocks.
SSGA has been also been overweight US high yield bonds during the past year because of their solid risk-adjusted returns. But the firm has become more cautious as “the credit cycle gets closer to its end”, he said.
The firm is also happy to take interest rate risk through exposure to the US 30-year Treasury bond.
There are signs of an economic slowdown in the US, but not a recession. Besides, the Fed has the capacity to cut interest rates if economic data were to sharply deteriorate, which is a luxury that the European Central Bank lacks, according to Anderson.
“If investors really believe a recession is coming, then they would turn to the US dollar as a safe haven. That would countervail downward pressure on the currency caused by a concurrent reduction in interest rates.
“Besides, even with Fed rate cuts, US Treasury bond yields would still likely be higher than the negative yields earned on some other developed market government bonds, including Germany.”
Among other traditional refuges, Anderson favours the yen, but considers the Swiss franc to be overvalued historically, and sees merit in gold, especially as some central banks, including China and Russia, have been recent buyers.
“Of course, the US-China trade dispute is now in central vision. Our base case is for a ‘pained deal’. Our risk-case is a lack of resolution that prompts an economic derailment. There is also the danger that the dispute will transform into a more general strategic containment of China by the US administration, but the economic consequences of a protracted trade conflict are greater than the geopolitical risks.”
The most probable outcome, according to Anderson, is that there will selective, mutual removal of tariffs ahead of president Trump’s re-election bid in 2020.
EM still attractive
Although State Street doesn’t take explicit country or sector bets, Anderson believes that emerging market equities are cheap compared with developed markets: they are trading on an average multiple of 11 times earnings, several percentages points lower than US or European markets.
Rising protectionism from developed markets such as the US is still an important risk for emerging markets. But, SSGA believes that the growth stories of two of the largest countries – India and China – continue to offer opportunities for investors in both the equities and bond markets.
“Emerging market equity valuations relative to other regions are at all-time lows, while earnings per share and sales forecasts are holding up well,” said Anderson.
“We think emerging markets are attractive and the long-term growth story is intact, although risks remain with the ongoing US-China trade dispute.
“For fixed income investors, higher-yielding emerging market debt should drive long-term returns despite local currency volatility in the short run. Overall, the stabilisation of the Chinese economy is positive for emerging markets,” he said.
European equities also trade at low valuations, but “there are a complexity of political and economic reasons why Europe is cheap”, he added.
In general, he believes macro factors should sustain corporate earnings growth. Investors, however, need to be cautious as volatility could easily spike given the significant geopolitical and growth risks facing the global economy, Anderson concluded.