The latest interest rate cut by the Federal Reserve means there are big decisions to be made on equity exposure, according to Premier Asset Management’s Neil Birrell, who said that a healthy outlook could push stocks higher.
At the end of October, the Fed cut interest rates for the third time this year as the target rate fell by a further 25 basis points to hover between 1.5 and 1.75 per cent.
Announcing the decision, Fed chair Jerome Powell maintained the latest cut was fitting for the uncertain environment, as the US-China trade war continues to rumble on.
Despite the rate cut, Birrell – chief investment officer at Premier Asset Management – said the wording used by Powell was significant, noting that the Fed chair had used the word “appropriate” several times when referring to current rates.
Effective Fed Funds Rate over 5yrs
Source: St Louis Fed
“The Holy Grail for central bankers is to manage the economy through the cycle and avoid excessive peaks and deep troughs,” said the Birrell, who oversees the multi-asset Premier Diversified range.
“It would seem that Powell must think he has a chance of achieving a soft landing for the US economy – which is good for us all – even though he did say ‘You never say you’ve achieved it’.”
Nevertheless, the latest rate cut could have several implications for asset classes.
“I think the biggest decision to be made on asset allocation now is equities,” said the Premier manager. “If the Fed has got this right, the medium-term outlook for equities has just improved.
“Firstly, equities are not that expensive. Global equities are trading on a P/E [price-to-earnings multiple] of around 16.5x for 2019, not expensive by historic comparison, yielding 2.52 per cent; significantly more than government bonds.
“If equity markets are to go up from here it could be through an expansion of the P/E ratio, they just get more expensive, or corporate earnings growth could push them higher; a healthier outcome.”
Indeed, Birrell noted that while corporate earnings growth in the first and second quarter of the year had not been strong, third-quarter results had not been as bad as expected and in some cases – such as Microsoft and Apple – had been impressive.
“This has helped drive the S&P 500 to record highs,” he added.
“Earnings forecasts for 2020 and 2021 currently suggest that there will be growth of around 10 per cent in each year. These aggregated bottom-up forecasts may not be that reliable, but if economic conditions are stabilising then they have a much better chance of being reached.
“If that happens then, arguably, equities look cheap, particularly relative to most other asset classes, with the support of an improving outlook.”
US equities are likely to lead the way in terms of earnings growth and as such the manager is maintaining a “healthy” weight of just over 40 per cent of its equity exposure across the range.
“We like the exposure and can find many good quality companies at attractive valuations to hold,” he explained.
“Our second largest weighting is in the UK, where we believe that striking valuations across the market will hold sway, as we move through this period of political uncertainty. In the Diversified Income fund, UK equities are the biggest weighting. The yield on offer is simply too good to miss.”
Yet, the multi-asset manager said he remains happy with the current level of equity exposure within the range.
“Our key decision is whether to increase our equity holdings, but risk management is vital, hence the hedges and diversification is key,” he explained. “That’s why we invest in bonds, property shares and alternatives as well as equities.”
By investing across multiple asset classes, Birrell aims to spread investment risk and increase the amount of investment opportunities.
One way in which, the manager is hedging against the Fed being wrong in his more cautious strategies is by maintaining a small position in 10-year US Treasuries where yields have risen since the start of the year.
“I don’t think the Fed’s decision will result in the bursting of the so-called ‘bubble’ in bond prices, or not for now anyway,” he explained.
“Inflation is not a big risk, rates are on hold, not rising and there are still many other risks out there, not least threats to economic growth from trade disputes. On the other hand, it is difficult to see bond yields falling much from these levels.”
Looking at corporate bonds, Birrell said current valuations are stretched and “any elongation of the cycle or a soft landing is a positive thing”.
“However, it’s not a sufficiently positive change for us to alter our view,” he added. “Where we do hold corporate bonds in the funds they are short duration, as high quality as we can find, to produce a decent return or have specific features to mimic those traits.”
Finally, while ‘safe haven’ gold has benefited from uncertainty this year, Birrell said the Fed’s comments on a stable outlook should inhibit any further rise in prices for the yellow metal.
Performance of Bloomberg Gold Sub vs MSCI World in US dollar over 1yr
Source: FE Analytics
“If the Fed is right and the outlook is more stable, then I can’t see the price of gold going up from here,” Birrell said. “We only have a small exposure to gold in the funds through gold mining company shares, whose price will not be overly sensitive to the commodity price.”
The Premier Diversified range includes a number of different strategies including Premier Diversified Growth, Premier Diversified Income, Premier Diversified Balanced Growth, Premier Diversified Cautious Growth and Premier Diversified Dynamic Growth.
The largest strategy in the range is the five Crown-rated Premier Diversified Growth fund, which has a long-term growth target.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Over the past three years, the £181.9m fund has made a total return of 29.78 per cent compared with a 20.25 per cent gain for the average IA Mixed Investment 40-85% Shares peer. The fund has a yield of 2.08 per cent and an ongoing charges figure (OCF) of 0.65 per cent.