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17 Sep 2018

US equities: How to invest at this stage of the cycle


Despite their strength and overwhelming popularity so far this year we still favour US equities, even at this late stage of the economic cycle. Seemingly rich valuations may limit long-term upside potential but we, like many others, have said that before and they’ve kept on running...   

US sectors: Current price-to-book ratios vs. 20-yr average  

table 1

Sources: Lyxor AM International, MSCI, ThomsonReuters Eikon, data as at 30/08/2018

 

Life in the old bull yet

There’s little doubt Trump’s belated, but unprecedented, fiscal stimulus should foster more inflation at a time the economy is running at or above full capacity. Strong top-line revenues and margin expansion (as well as share buybacks) have bolstered the earnings-per-share outlook for corporates, while recovering capex and the associated upturn in productivity could help mitigate the negative effects of rising wages. All of which suggests there’s some further upside ahead. Little wonder investors are still being drawn to the US, despite the unpredictability of the administration on the Hill and the looming mid-terms.

That said, we do expect more volatility in the coming weeks, given the policy and political pipeline. We’re expecting another rate hike later this month, after which all eyes will turn to the politics. Further trade tensions lurk.  

Trade turmoil takes its toll, but expansion continues

Recent US ISM surveys have reached new cycle highs and the job market has remained strong, suggesting solid growth in the coming months. Outside the US, business survey results such as PMI manufacturing in emerging countries and Europe have dipped on the trade tensions, but they’re still pointing to economic expansion. That could change should the trade war escalate or become more global in nature but we still think a negotiated settlement is ultimately more likely. In truth, a move from sporadic, temporary sell-offs into a lasting bear market requires a more meaningful, cyclical turn down – something we don’t foresee just yet.  

 

You are here

Although every business cycle is different, they do tend to follow a similar pattern. Convention has it that when an economic recovery matures, the energy and materials sectors – which are closely tied to raw material prices – tend to do well. That’s because inflationary pressures are building and demand for these goods is still solid. On the other hand, IT and consumer discretionary stocks tend to suffer because their profit margins are being eroded and investors are becoming more wary of luxury spending.  

We’re seeing some of this today in the US with the recovery now entering its dotage, but there are specific issues helping some sectors defy convention.

 

table 2

 

 

Of size, sectors and styles

When assessing US equity allocations today, you have to factor in the fallout from the fiscal push. It helped US corporates avoid typical late-cycle like slowing earnings growth and a squeeze on profit margins and also ensured a favourable environment for Financials and Technology, through deregulation and tax reform respectively.  

Quite naturally, we also favour some more conventional late-cycle calls, including Energy and Healthcare. Energy in particular appeals because of its improved corporate fundamentals and the recovery in oil prices.  

There are some areas we’d rather avoid too. We’re wary of the Consumer Discretionary sector given company-specific risks and problematic valuations, particularly in e-retailing. We’re also keeping a watchful eye on the most defensive sectors – especially those more sensitive to interest-rate rises including Telecoms, Utilities and Consumer Staples. 

Meanwhile, Trump’s tax cuts should still stimulate additional profit growth for smaller companies, many of which benefit from a domestic bias to their business – making them slightly less vulnerable to the ongoing trade disputes.

Style-wise, we still favour growth given the importance of robust earnings growth and sustainable profit margins right now.  Those tax reforms should continue to boost capex, cash repatriation and, ultimately, tech - a sector which currently represents around 30% of all US capex and around 40% of the Russell 1000 Growth Index.

 

Choose your index wisely

Precision and selectivity then are the watchwords at this late stage of the cycle. Look to lower cost exposures to make the most of whatever upside remains, tilt towards tech or bet on the specific issues boosting banks with indices like the Morningstar US Large-Mid Cap, the NASDAQ 100 or the S&P Banks. Play energy with the Russell 1000 Value, or the small-cap theme with the Russell 2000. Alternatively, you could seek to add some resilience to your portfolio with quality income or minimum variance strategies.

Explore the indices

 

How the indices breakdown vs. our views

Sector we like Indices with the greatest exposure
Energy Russell 1000 Value (10.91%)
Financials S&P 500 Banks (100%), Russell 1000 Value (28.2%), Russell 2000 (20.6%)
Inf. Technology NASDAQ 100 (60.9%), Russell 1000 Growth (39.7%)
Healthcare Russell 2000 (16.5%)
Sectors we’d rather  avoid Sectors we’d rather avoid
Consumer discretionary Nasdaq 100 (22.2%), Russell 1000 Growth (18.6%)
Telecoms*  FTSE USA Qual/ Vol/ Yield (6.0%)
Utilities  FTSE USA Core Infrastructure (52.3%), FTSE USA Minimum Variance (11.9%)
Consumer staples FTSE USA Qual/ Vol/ Yield (17.3%)

 

Source: Lyxor International Asset Management, Data as at 30/04/2018. For illustrative purposes only. *This sector will be broadened from 24 for S&P indices and end-November for MSCI indices to include stocks from media & internet software & services sectors. At that point MSCI will reclassify the sector as cyclical and we expect the sector composition to move to a growth-tilt from its previous domestic value bias   

 

Capturing opportunity with Lyxor

If you still see the US as a land of opportunity, look no further. Our US equity range opens up 14 possible routes to travel, across mainstream and more specific indices from just 0.04%. And, because we’ve been managing ETFs in the region for over 16 years, and run over €8bn* in assets, we may just be the guide you need.

See the range

* Source: Lyxor International Asset Management. Data as at end August 2018. TERs correct as at 11/09/2018

Important information

FOR QUALIFIED INVESTORS ONLY– This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).

This document has been provided by Lyxor that is solely responsible for its content.

fund table ch

The funds that are listed in the chart comprised in this document (Funds) are collective investment schemes not approved by the Swiss Financial Market Supervisory Authority FINMA (FINMA) as foreign collective investment schemes pursuant to article 120 of the Swiss Collective Investment Schemes Act of 23 June 2006 (as amended from time to time, CISA) for distribution in Switzerland. Accordingly, the non-Registered Funds may be offered in Switzerland exclusively to Qualified Investors as defined in the CISA and its implementing ordinance.

 Lyxor Research document This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).

Financial intermediaries (including particularly, representatives of private banks or independent asset managers, Intermediaries) are hereby reminded on the strict regulatory requirements applicable under the CISA to any distribution of foreign collective investment schemes in Switzerland. It is each Intermediary’s sole responsibility to ensure that (i) all these requirements are put in place prior to any Intermediary distributing any of the Funds presented in this document and (ii) that otherwise, it does not take any action that could constitute distribution of collective investment schemes in Switzerland as defined in article 3 CISA and related regulation.

 

Any information in this document is given only as of the date of this document and is not updated as of any date thereafter.This document is for information purposes only and does not constitute an offer, an invitation to make an offer, a solicitation or recommendation to invest in collective investment schemes.  This document is not a prospectus as per article 652a or 1156 of the Swiss Code of Obligations, a listing prospectus according to the listing rules of the SIX Swiss Exchange or any other trading venue as defined by the Swiss Financial Market Infrastructure Act of 19 June 2015 (as amended from time to time, FMIA), a simplified prospectus, a key investor information document or a prospectus as defined in the CISA. An investment in collective investment schemes involves significant risks that are described in each prospectus or offering memorandum. Each potential investor should read the entire prospectus or offering memorandum and should carefully consider the risk warnings and disclosures before making an investment decision. Any benchmarks/indices cited in this document are provided for information purposes only.

 

This document is not the result of a financial analysis and therefore is not subject to the “Directive on the Independence of Financial Research” of the Swiss Bankers Association.This document does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investments in financial products. 

The Representative and the Paying Agent of the Funds in Switzerland is Société Générale, Paris, Zurich Branch, Talacker 50, 8001 Zurich. The prospectus or offering memorandum, the key investor information documents, the management regulation, the articles of association and/or any other constitutional documents as well as the annual and semi-annual financial reports may be obtained free of charge from the Representative in Switzerland. In respect to the units/shares of the Funds distributed in and from Switzerland, place of performance and jurisdiction is at the registered office of the Representative in Switzerland. 

Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

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