Investors should be reluctant to fully embrace an ‘America First’ investment strategy despite the strong momentum in markets this year, according to Sarasin & Partners’ Guy Monson.
Massive tax cuts late in the business cycle, deregulation and an aggressive trade agenda set by US president Donald Trump have certainly benefited the US economy so far this year.
Indeed, it is the only major economy that is on pace to see growth accelerate at a faster rate in 2018 than in 2017, as the below chart shows.
Graph of growth in 2017 and forecasts for FY 2018
Monson, who co-manages the Sarasin Global Higher Dividend fund, said: “America First – including tax reform – has been more successful at lifting economic growth than many dared expect and momentum remains strong, with US consumer confidence running at an 18-year high.”
However, the Sarasin chief investment officer added that it has “left a troubling backwash for the rest of us”, with the subsequent rise in the US dollar, oil prices and interest rates causing damage to other economies.
As such, despite overall global growth continuing to climb and the synchronised recovery from a year ago still largely intact, it is a far murkier picture.
Indeed, although the US has been the biggest winner, the emerging markets have come out worst from the effects of Trump’s policies as they are naturally more vulnerable to a stronger dollar and rising oil prices that typically come with sharply accelerating US growth.
“While Iran, Turkey and Russia are at the apex of US sanctions, the cooling momentum in the Chinese economy is of particular note,” Monson said.
“Beijing was already attempting to rein in risky domestic lending when confronted by an asymmetric trade battle with the US – where ‘China hawks’ in the White House, led by Peter Navarro, appear to have the upper hand.”
With US mid-term elections approaching, the fund manager added that negotiating a deal with China may not be in the president’s best interests among his core vote, meaning a breakthrough is unlikely.
“More likely is that president Trump will again up the ante and see if Beijing blinks, while domestic Chinese policy is already ‘reverting to type’ with increased spending on construction and an easing of lending standards designed to stabilise domestic growth,” he said.
One area that has struggled this year is Europe, with the MSCI Europe ex UK index lagging the S&P 500 by 11.29 percentage points in sterling terms. However, that has little to do with the US.
Monson said: “Europe, despite its very large trade surplus, is currently among the regions least impacted by US sanctions, with implementation of tariffs by the US on hold after the meeting between [Jean-Claude] Juncker and Trump in July.
Performance of indices over YTD
Source: FE Analytics
“While some blame can be laid at the door of US policy, Europe’s internal challenges have certainly amplified the impact.”
First is the Brexit overhang, which continues to muddy waters, along with ongoing uncertainty surrounding Italy and fragmentation between different countries’ interest rate policies also causing friction.
So, judging by all of this, the US remains the place to invest. However, can the short-term boost that president Trump’s policies have provided last much longer?
Monson said there are three risks to the US economy. First is that all the positive work done on the trade negotiations in terms of narrowing the US deficit could yet be unwound by further rises in the dollar, leading to a currency war.
Second, is that the US bond market finally s fright at the explosion of Treasury issuance required to fund the swelling US budget deficit, he said.
“The sell-off would be exacerbated by the Federal Reserve’s concurrent reduction of its mountain of Treasury holdings, which began at the end of 2017 and is likely to continue until at least late 2019,” said the Sarasin Global Higher Dividend fund manager.
Finally, it could be that US equity valuations correct as a combination of a strong dollar, rising interest rates and trade restrictions crimp next year’s earnings projections.
“This makes us reluctant to fully embrace an America First investment strategy despite the strong momentum in markets in favour of the US dollar and US equities,” Monson said.
Partly this is because the upward revision of earnings is likely already priced into the markets, with the S&P 500 trading at around 20x historic earnings versus less than 14x for Europe.
“Incorporating the anticipated uplift in US corporate profits one year ahead, the US multiple falls to 16x, which still represents a 15 per cent valuation premium over Europe even if we assume no European earnings growth,” he added.
However, while there are risks, Monson noted that the sheer strength of US profit growth suggests investors should not be cutting positions wholesale just yet.
“Yes, at current valuations, compelling individual opportunities are appearing in Europe and potentially Japan – we would be adding, but gradually, on a stock-by-stock basis,” he said.
Meanwhile, adding selected positions in US defensive equities as well as those that play into themes such as ageing and dietary trends may be worth investing in.
“[Additionally] US banks continue to offer an unprecedented capital return story while acting as a useful hedge against interest rate risks,” he added.
As well as this, if trade tensions do get resolved, the gap in investment performance between the US and the rest of the world, which has been baked-in due to fears of a trade war, will likely narrow.
“Under this scenario, selected higher-quality emerging market assets offer compelling value for a long-term investor,” Monson said.
However, the exception to this may be China, where White House policy appears to be more antagonistic and less open to constructive negotiations.
As such, he said he is “comparatively cautious” on Chinese economic risk and “sceptical” as to the ultimate effectiveness of their current stimulus plan.
Monson has run the £394m Sarasin Global Higher Dividend since 2016 with co-manager Neil Denman and deputy Julian Bishop joining him in July this year replacing former co-manager Guy Davis.
It has been a top quartile performer over the past five years and is up 40.51 per cent since Monson started on the fund – beating the IA Global Equity Income sector average by 2.81 percentage points.
Performance of fund vs sector since manager start
Source: FE Analytics
Currently the income-focused portfolio is 43.7 per cent weighted to the US with 23.8 per cent in Europe and 18.9 per cent in the UK.
Sarasin Global Higher Dividend has a yield of 3.14 per cent and a clean ongoing charges figure (OCF) of 0.98 per cent.