A continuing bull market run or a looming recession in the world's biggest economy? Just where is the US headed?
Right now, with US financial markets emitting contrasting signals, it's no surprise opinion is mixed among asset owners and wealth managers in Asia.
Getting the call right, though, could have big consequences for investment performance, because while some investors are turning cautious and making their portfolios more defensive, others are raising their allocations to risk assets -- US risk assets.
In large part, allocation decisions are being decided according to which part of the market investors choose to focus on.
On the one hand, the widely tracked S&P 500 equity index continues to scale fresh peaks, hitting 2888.6 on September 5 to extend an already-record, nine-and-a-half-year bull run as investors cheer improving corporate profits and outlooks.
On the other, a flattening yield curve in the US government bond market (a narrowing between short-term and long-term interest rates as the former rise by more than the latter) is hinting at something altogether different: an economic downturn, especially if the trend continues.
Currently, the spread between the two-year and 10-year Treasury bond is the narrowest it has been in a decade. In the past, every time the yield curve has inverted (where the two-year yield rises above the 10-year bond yield), it has led to a US recession -- and a global economic downturn.
For some asset owners such as Prudential Malaysia, who are more bond-investment oriented, US bond market conditions are stoking concerns about recessionary conditions and leading to a more cautious investment stance. As a result, Prudential Malaysia is seeking the safety of local bonds, its chief investment officer Esther Ong has said.
A flattening yield curve suggests investors are pricing in further hikes in short-term US interest rates, even as the $1.5 trillion tax cut announced last year threatens to stoke inflationary pressures in an economy chugging along at low unemployment levels, thinks James Cheo, senior investment strategist at Bank of Singapore.
“At the long end [of the US yield curve, meanwhile,] bond investors are still uncertain about the future and given that we are in the late stages of the market cycle, don’t know what will tip it over,” he told AsianInvestor.
The possibility of a US recession was also flagged by Singaporean state fund Temasek at its annual investment review in July.
REASONS TO BE CHEERFUL
Investors eyeing soaring US company share prices are getting quite a different message from the gloomy scenario painted by bonds.
They are being encouraged by strong earnings growth, which they believe will continue, fuelled by the tax cuts.
Money managers for high-net-worth individuals, such as Tuan Huynh, chief investment officer for Asia Pacific at Deutsche Bank Wealth Management, believes US equity markets will continue outperforming – and has rejigged allocations accordingly.
“We increased our allocation of US equities by 3% in June this year ... to reflect our view, while we have reduced our allocation of European equities and Japanese equities by 2% and 1%, respectively,” he told AsianInvestor, in reference to the wealth manager's discretionary mandates.
That sentiment is echoed by Hou Wey Fook, chief investment officer for DBS’s consumer and wealth banking, who notes that even after years of gains, along with a 6% expansion in the S&P 500 this year, the price-to-earnings ratio, a widely used metric to assess whether a stock is expensive or not, stands at a “not excessive” 16 times for the index.
He told AsianInvestor that his team has been bullish on US equities and will continue to be so.
Still, concerns persist about the breadth (or lack thereof) of this year’s Wall Street rally: “44% of the S&P 500’s year-to-date performance has come from just five stocks (Apple, Amazon, Google, Microsoft and Netflix),” notes Mark Sherlock, head of US equities at Hermes Investment Management. Technology-related stocks account for about a quarter of the S&P 500.
His investment team’s reaction to the market climb has been to become more circumspect.
“We have taken some profits in names where we feel valuations have become stretched (particularly elements of the technology and biotech sectors)," he told AsianInvestor, "[and are] reinvesting in stocks that are more reasonably priced, with strong balance sheets and [show] high levels of recurring revenue.”
While it feels challenging to reconcile what bond and equity markets are telling investors about the future, Jan Amrit Poser, chief strategist at Bank J Safra Sarasin, believes it is possible to weave all the signs into a coherent message.
“When the yield curve inverted back in 2007, it took a year and a half before a recession actually began [in the US],” he said at a media briefing in Hong Kong earlier this week, suggesting that even if a recession is on the cards for the US, it may be some time away.
In the meantime, equity markets could keep on climbing -- just not necessarily in emerging markets, which are feeling the strain as capital flows back to developed markets, especially the US.