SINGAPORE (Dec 10): In the last few years, passive fund management has become increasingly popular among investors, as its returns have often outperformed those of active investing. One reason
for this outperformance can be attributed to the ultra-loose monetary policy environment in the aftermath of the global financial crisis in 2008.
But, now, as the US Federal Reserve is expected to continue to normalise interest rates and reverse its asset-purchase programme, passive management may no longer yield attractive returns. Instead, such opportunities may lie with active investing again, according to Liz Ann Sonders, chief investment strategist at Charles Schwab.
Main image: Sonders (right) advocates for a defensive approach in one’s portfolio
“That is why active funds are seeing inflows, while passive funds are seeing outflows,” she says. “We are going back to a more normal environment, which is not driven by central bank liquidity anymore. Although volatility is likely to remain higher, you will see a greater dispersion in economic prospects, central bank policies, inflation and the performance of stock and bond markets.”
As such, Sonders says broad and global diversification is key to potentially gaining attractive returns. This is especially so since Singapore investors tend to have a home bias. Sonders says it is important for them to get some diversification exposure to the US equity market because of its pole position. “Given the power and weight of the US in the global economy and equity indices, not having exposure to that market is a noticeable absence in an investor’s portfolio,” she says.
STRONG US ECONOMY AMID RISKS
So far this year, the US economy has been strong. The country’s GDP accelerated 4.2% in the second quarter — the fastest pace since late 2014, although that was followed by a slightly more tepid 3.5% in the third quarter. This came on the back of elevated business confidence and higher consumer confidence/spending, enhanced by US fiscal stimulus, including tax cuts, and other budget-related spending. The exuberance has led some to think the US is on the brink of a new high growth trend, says Sonders.
However, Sonders says she is not one of them. This is because the strong second-quarter growth was largely driven by the frontloading of imports from China by US companies, as well as exports to China, in an attempt to avoid tariffs triggered by the trade war, she says. This means the inventory building that contributed to strong growth in the second quarter is likely to reverse as companies work off their existing inventories, she adds. In addition, the strength in the US dollar is putting downward pressure on US exports, leaving aside the impact from the trade war.
With a potential slowdown in US and global economic activity, the risk now is that the current prolonged economic cycle may soon be coming to an end. The US economy may be transitioning to the phase in the economic cycle when economic growth is decelerating, but inflation is still accelerating (somewhat courtesy of tariffs), says Sonders. This will keep the Fed on guard as it weighs its dual mandate of labour market and inflation conditions, she adds. The contraction in global liquidity, deteriorating credit conditions and tightening financial conditions will also be keenly observed. The upcoming G20 meeting could also provide some cues, especially with regard to the near-term path for trade.
In fact, trade could be the “wild card” that determines whether the US economy weakens enough to bring on a recession, says Sonders. Already, some US$250 billion ($344.3 billion) worth of Chinese exports to the US have been slapped with tariffs; conversely, some US$110 billion worth of US exports have been imposed with tariffs. An agreement to pause or stop the trade war between both countries has so far failed to materialise. In fact, the US is reportedly mulling over the decision to impose tariffs on the remaining US$267 billion worth of Chinese exports.
This has contributed to higher volatility in the US equity market. In terms of the G20 meeting, Sonders says: “I don’t think the market has priced in one extreme or the other. I think the market has priced in uncertainty. If there is no agreement, it’s likely the US will institute the remaining tariffs, which would likely be an economic and stock market negative. But if we get an agreement — or more likely some sort of truce — the reaction would likely be quite positive.”
This uncertainty has caused many US companies to pause in their capital spending plans while they wait for some of the uncertainty to clear. Sonders notes that consumer companies such as Walmart are planning to pass on costs to consumers, while the dominant US auto makers — General Motors and Ford Motor Co — have made announcements of either pending or considered global workforce layoffs (for reasons other than just tariffs’ pressures). Meanwhile, industrial companies such as 3M and Caterpillar are taking significant profit hits from tariffs. If the additional tariffs on US imports from China are instituted, the impact on corporate earnings and the overall US economy will expand.
The unpredictability of US President Donald Trump only makes it more difficult for forecasting and budgeting. Trump, for instance, had previously posted on Twitter that he was confident of reaching a deal with Chinese premier Xi Jinping, following a call with the latter. However, members of his administration — including its top economic adviser Larry Kudlow — subsequently denied the occurrence of any negotiations, says Sonders. More recently, Trump warned that he was “highly unlikely” to delay an increase from 10% to 25% in overall tariffs on Chinese goods at the beginning of next year.
It does not help that China tends to keep its cards close to its chest. “Xi is not on Twitter every day. So, there is a curtain in front of what China is going to do,” says Sonders. “That’s why I think it’s impossible to make a judgement on how the trade war will turn out.”
While the recent two US recessions were triggered by the popping of major bubbles and financial crises, Sonders thinks the next recession will be more of the “garden variety” type. This is because she sees no large systemic bubbles waiting to explode. On the contrary, she says, “we have had a number of ‘micro bubbles’ (such as cryptocurrencies), which so far are being popped individually on a rolling basis without the whole system coming down”.
So, how should investors play the US stock market? Sonders advocates for a defensive approach in one’s portfolio. “Aside from diversification, we are emphasising the need to rebalance because, with greater volatility and dispersion among asset classes, your portfolio is going to get out of whack,” she says.
In particular, Sonders is “overweight” on US large caps. Within this space, she is “overweight” on stocks in the healthcare sector because they offer long-term growth potential in tandem with a growing ageing population.
On the other hand, Sonders and her team downgraded the technology and financial sectors from “overweight” to “neutral” in August, in an effort to guide investors away from growth/momentum towards value/defensiveness. Also, “we felt that certain areas of technology — such as the ‘FAANG’ stocks — had become a very crowded trade”, she says. “This may not be a long-term recommendation, given still-strong earnings fundamentals — but an appropriate way in the near term to add some defensive characteristics to portfolios.”
As for the financial sector, although many stocks in this sector will see net interest margins benefit from higher interest rates, “the flattening of the yield curve means a narrower spread between the rates at which banks borrow and lend”. On the other hand, at the same time in August, Sonders and her team upgraded stocks in the utilities and real estate investment trust (REIT) sectors to “neutral” from “underweight”, owing to their defensive nature.
Ultimately, one of the most important steps investors can take is to truly understand their risk tolerance, says Sonders. This should not be tied solely to an investor’s time horizon, but also to his or her investing behaviour and emotional fortitude around investment losses, she elaborates. The common perception is that a young investor can adopt a more aggressive, risk-taking position compared with an older investor. In reality, however, a person’s tendency to panic in response to market movements is an equally important factor to consider, explains Sonders.
CHARLES SCHWAB IS COST-COMPETITIVE
Singapore investors who intend to gain exposure to the US market can consider doing so via Charles Schwab, a leading US brokerage firm. Charles Schwab offers mass affluent and high-net-worth Singapore investors the opportunity to invest directly in a variety of US investment products, on the same low-cost structure as a US investor. These include equities, exchange-traded funds (ETFs), options, futures, offshore mutual funds and fixed-income products, all of which are denominated in US dollars.
The firm also provides specialised services such as proprietary Schwab Equity Ratings, sophisticated stock screeners, third-party research and trading software for active investors. In addition, Charles Schwab organises webinars and workshops to help investors learn more about trading and investing in the US market.
Last year, Charles Schwab opened its Singapore affiliate at One George Street. Greg Baker, managing director of Charles Schwab Singapore, says the firm is able to meet a gap in the market: “Our belief is that clients here are underexposed to the US market, principally because, when they approach their local broker, they are forced to pay high fees. That is a discouragement.”
On the contrary, Charles Schwab’s value proposition is competitive. It does not charge fees for custody (publicly traded securities), data access nor platform usage. The equity commission fee is a flat rate of US$4.95 per online trade with a number of ETFs on its ETF One Source offer at zero dollar commission. “We really drive down the cost for our clients,” says Baker. “We want to grow with them.”
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