Overview
After a tumultuous few months, it would be easy to bank, and bank on, another quarter of strong performance for growth stocks. Yet concerns over the shape of policy, the economy, and interest rates are writ large across current conversations with investors. The latest episode of Fidelity Answers assesses those risks - and what we should be doing about them - with three portfolio managers tasked with providing some of the alternatives.
Two of our guests this month focus on strategies that aim to provide a regular income from investment and use it to generate returns. Tristan Purcell, a dividend-focused equity income investor, is worried chiefly by over-concentration in - and within - US markets.
“Compared to any historic period we're in an extremely concentrated environment,” he says. “The US is two thirds of world markets. And Big Tech plus the magnificent seven stocks comprise nearly half of the US market. Whenever you have periods of extreme concentration like that, it introduces risk, particularly if you're taking a passive or a benchmark-aware approach.”
The question is what happens when it all unwinds.
“In the dotcom era you had five years from 2000 to 2005 where the S&P fell around 10 per cent in aggregate, whereas the S&P equal-weight expanded around 30 per cent.”
Multi-asset portfolio manager Caroline Shaw has profited from the bounce in US markets since the tariff shocks of Liberation Day, but she too feels uneasy with more of the same: “Breadth is really important. We should look more widely for other opportunities in the market.”
Interest in rates
This is not a new debate. It has dominated the past 18 months. And on each occasion, the straight, US-centric growth plays have emerged stronger.
Could a White House-driven shift in US monetary policy change that pattern?
An important facet here, says fixed income portfolio manager James Durance, is the seeming tension between inflationary pressures in the US, which would naturally keep rates high, and the current administration’s pressure on the US Federal Reserve to cut borrowing costs. The result has been a rise in longer-dated government bond yields that could continue if the market grows more concerned.
“That leaves me a little bit nervous,” Durance says. “And it means that the amount of US duration I have is not that high.”
Inflation, in this scenario, also presents a complex headache for equities. Prices have remained sticky in the US, with little impact on US consumers so far. Companies still have not reflected the true measure of tariffs either, Shaw says. That means inflationary pressures have yet to hit either the consumer or company margins, which could spell trouble ahead for US assets.
Durance argues there is a further complication if the US decides to drastically lower rates. Usually, a lower rate environment would signal recession, which would be bad for credit (owing to increased rates of default). But that logic has inverted since the advent of quantitative easing. An abundance of cheap money has, counterintuitively, pushed investors into riskier, higher yielding credit at a time when recession has appeared more likely - and Durance expects something similar to happen this time were the US to head into a recessionary scenario.
This means much rests on both whether the Fed does cut rates, and - assuming it does - why. Nobody can know the answers to these questions for now. That ambiguity reinforces the need for diversification.
Diversification incoming
Purcell’s task, from a regional perspective at least, looks the most straightforward. He is happy to continue allocating away from the US and towards Europe. Likewise, Shaw sees the key variable here as fundamentals in US companies: were earnings among those seven magnificent leaders in the US to slow, then US market performance suddenly wouldn’t look so different from the rest of the world. That would trigger a significant reappraisal of portfolio allocations.
In Purcell’s hunt for reliable dividend payers, he’s looking for businesses that have the sort of pricing power that allows them to front run rising costs with their own price rises. Financials, too, are attractive, particularly insurance companies. He explains: “[These companies] are not economically sensitive, so we find them particularly appealing”.
For Durance, there are different signals across government debt and credit. In the credit market, he explains that he is essentially looking for the spread over a risk-free rate i.e. a corporate bond yield over that of Treasuries. He can use that figure as the basis by which to compare the relative value in credit around the world, adjusting for things like credit quality. Despite volatility earlier this year, he finds US credit is once again looking expensive.
“My takeaway,” says Shaw, “is that there are some good opportunities in equity income, but also that there is a breadth of opportunity in fixed income that gives us room to think about different ways of getting exposure. So I’m quite excited about some of the positions we can put into portfolios to give us that resilience.”
