Outlook for US equity funds positive despite trade war

So why are European and UK equity funds vulnerable to trade tensions? 

Impact on European and UK equity funds 

Ernst Knacke, fund research analyst at Quilter Cheviot explains how European markets will suffer more than the US because of its reliance on global growth. 

He says: “Given the US consumer is 70 per cent of the US economy, an escalation of the trade war may result in higher input costs and cost inflation. This is then borne by the consumer [which may] result in a slowdown and ultimately a recession in the US.” 

He adds: “Perversely, consequences of such an event might be worse for European markets given their reliance on global growth.”

Key facts: 

• Trade tensions between the world’s two largest economies have been bubbling on since 2017, when the US launched an investigation into US trade policies.
• Last year, the US imposed tariffs worth on more than $250bn worth of Chinese goods. China retaliated by launching tariffs on US goods worth $110bn. 
• A truce reached between both countries collapsed year. 
• The US had threatened to impose further tariffs worth $300bn of US goods but positive developments at the G20 last month means both countries are engaging in further negotiations. 

Mihir Kapadia, chief executive of Sun Global Investments, thinks the US is likely to outperform UK and European equity markets, especially given the dominance US tech firms. 

He adds: “This will continue to have a huge sway in the future and although more expensive, will be a useful diversification tool.”

Mr Kapadia thinks Europe is showing signs of a slowdown despite low valuations and imminent easing by the European Central Bank. 

Jason Hollands, managing director of Tilney Investment Management, confirms this view .

“Paradoxically, a deterioration in the Chinese economy might actually hit Europe harder than the US, since the European economy is more exposed to exports and Europe’s equity markets have a much higher exposure to a cyclical sector,” he says. 

Diversification 

Several commentators stress that US equity funds will help investors diversify away from UK and Europe amid a volatile geopolitical landscape.  

Anthony Willis, Investment Manager BMO GAM’s multi-manager team, says: “Our view is that it pays to have a portfolio that is diversified internationally to give exposure to companies operating in other parts of the world, often in faster growing sectors and economies.”

He warns that investors who only hold UK and European assets could be potentially missing out on significant returns by failing to look further afield. 

Mr Willis adds: “We would argue that as well as investing in the US, investors should ‘look east’ as well towards Asian, Japanese and emerging market funds for a truly diversified portfolio.”

Mr Knacke highlights how the US equity market can deliver very strong returns for investors during turbulent times for Europe and the UK, in the way it did during  the Euro crisis. 

“This should be a big consideration for investors as Brexit and knock on effects of this on Europe looms,” he adds. 

As well as investing in the US, investors should ‘look east’ as well towards Asian, Japanese and emerging market funds Anthony Willis

On July 23, Boris Johnson won the leadership race to become Tory party leader and UK prime minister.

Mr Johnson has long adopted a hardline approach to Brexit and threatened to pull the UK out of the EU even if no deal is reached by October 31, the deadline for the UK to leave the bloc. This adds further uncertainty to UK's financial market. 

But Sheridan Bowers, head of UK and Ireland at Vontobel Asset Management takes a more neutral view. 

“We believe it is too simplistic to make generalisations such as “the US is growing faster than the UK or Europe”, the stock markets where companies are listed (UK, Europe or US) do not accurately reflect where the companies are doing business and therefore the opportunities or risks for these businesses and therefore investors.”

He adds:  “This is an unpredictable bottom up issue where each company has different exposures and have to adapt in different ways.”

Fed rate cut 

Many in the industry warn that more than trade tensions, US equity funds will in fact be boosted by the Federal Reserve’s widely anticipated interest rate cut at a monetary policy meeting on July 30-31. 

Mr Hollands says: “What should be a source of caution towards US equities at the moment are stretched valuations in parts of the market, but with Fed policy remaining very accommodative, it is quite possible that the market could continue to nudge higher in the medium term.”

The Federal Reserve is expected to cut interest rates, bowing to pressure by US president Donald Trump, by 25 basis points at the meeting. 

This would mark the first US interest rate cut in almost a decade. 

Mr Willis says: "The outlook for US equities will be determined by three things – the outlook for the economy and corporate earnings, the outlook for interest rates, and the electoral cycle.”

He explains that while the expectation of this rate cut has boosted US equities over recent months, there are concerns over the economic outlook and that “political noise will escalate from here into the 2020 election”. 

“But if the economic data shows signs of stabilisation, then there is scope for US equities to push higher, boosted by further interest rates that are expected over the next six months,” he adds. 

saloni.sardana@ft.com