Naomi Rovnik
LONDON (Reuters) – Global investors are eyeing European and emerging market assets to protect themselves from further turmoil in U.S. equity and bond markets as persistent inflation prompts a review of bets on the timing of interest rate cuts by the Federal Reserve.
April was a bad month for Wall Street, with the stock index and U.S. Treasuries reporting their biggest monthly losses since September.
Financial managers are now looking for ways to limit losses if the trend doesn’t reverse.
That could involve a restructuring of portfolios that have been boosted for years by high-priced U.S. stocks, said Sonia Loud, chief information officer at Legal & General Investment Management, which manages about $1.5 trillion.
“Diversification will be much more important in the future,” she said, adding that LGIM had not expected higher returns from global stocks but now favored European stocks over those from the United States.
Amelie Derambouret, senior multi-asset manager at Amundi, Europe’s largest asset manager, said she still expects long-term gains from U.S. stocks but bought put options to protect against a 10% fall. It also moved some cash from Treasuries into eurozone bonds.
The S&P 500 fell 4.2% in April.
ENTER EUROPE
US stocks have contributed about 80% of the price return of the MSCI World equity index since 2020 in dollar terms, Pictet Asset Management calculated.
The Magnificent Seven group of technology stocks, fueled by the artificial intelligence boom, contributed more than 60% of the S&P’s total gains last year.
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But as persistent inflation raises expectations that the Fed will keep U.S. borrowing costs at a 23-year high of 5.25%-5.5% or even rise again, the cost of betting on long-term gains from big tech companies’ big AI investments Compared to storing cash, it rises.
The sharp decline in shares of Facebook owner Meta (NASDAQ:) in April underscored the risks of hopes for stellar returns from tech companies as rates remain high. Until recently, markets expected the Fed to begin cutting rates in June.
The S&P remains highly valued, with its price-to-earnings ratio nearly 7 percentage points higher than Europe’s, LSEG data shows.
Investors said Stoxx is attractive because it includes companies in so-called value sectors such as banking and energy, which benefit from robust global growth but are generally unaffected by rising borrowing costs.
“We are expanding our presence in Europe,” said Luca Paolini, chief strategist at Pictet Asset Management. “The overall macroeconomic outlook favors a low-cost, cyclical value market.”
European fund manager Carmignac trimmed some U.S. technology holdings in April and was looking for opportunities closer to home, said Frédéric Leroux, head of the cross-asset group.
“Diversification towards Europe makes a lot of sense today,” he said. “Every time you have another wave of inflation (in the U.S.), you will see Europe outperform significantly.”
Moderating inflation in the eurozone means the European Central Bank is expected to start cutting interest rates on June 6.
Ross Yarrow, managing director of US equities at investment bank Baird, said global investors have been largely negative on US equities from a valuation perspective.
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But superior earnings growth has also helped Wall Street outperform Europe in 12 of the last 16 years, he said.
EXECUTIVE BEARS
The Treasury index fell about 2% in April, its worst month since September.
Amundi’s Derambure said she still expects Fed cuts but has increased eurozone government bonds in recent weeks to wait “for this erosion of US fixed income to end.”
Traders expect a 35 bps cut in US rates. this year, but by 65 bps. in the eurozone, where inflation has fallen closer to the ECB’s 2% target.
Treasuries may not rise even if the Fed does cut rates due to high and rising US government debt, according to Barclays strategists.
However, emerging market bonds are attracting buyers as investors look to see strong economic growth in countries such as India, Indonesia and Vietnam.
LGIM’s Laud added that she was bullish on Indian bonds, which have been snapped up by foreign investors ahead of inclusion in a major debt index later this year and amid an economic boom.
“Within fixed income, we see the best opportunity from a risk perspective (from) emerging market dollar debt,” said Manulife chief investment officer for multi-asset solutions Nathan Tooft.
CONFUSED
Diversifying US assets can be challenging.
Stoxx tends to track the S&P, with an 88% correlation between the two markets since 1986, Baird’s Yarrow calculates.
Treasuries also have a big impact on other debt markets, with a 1 percentage point rise in the U.S. 10-year yield typically leading to a 56 basis point rise in global yields, a Barclays study found.
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“It’s always very difficult to say, ‘OK, I want to be softer on the U.S. and invest more in other parts of the world,'” said Leroux of Carmignac.
“But even with correlations, there are times when you can achieve better results elsewhere.”