Following a strong start to the year, US markets look close to their valuation highs versus other global equity markets, and schemes should consider hedging some of their positions to protect against a retreat back to lower levels, River and Mercantile Solutions’ Barbara Saunders has said.
US markets are up some 17% year-to-date despite having suffered some volatility during May, and remain well ahead of the UK and many other indices globally this year.
Saunders, managing director at River and Mercantile Solutions, said investors faced a dilemma with the US despite the relative valuation difference, as it could continue to climb from here.
As such, she suggested maintaining some long exposure but protecting against the downside at the same time.
“The US looks overvalued again, so we have derivatives on for protection,” she said.
“This caps the upside our portfolios can benefit from going forward, but it also protects against the first 10% fall in valuations.”
A short-term trade, the team will review whether it needs to be renewed within the next month as the situation is highly fluid. In recent weeks expectations have been growing for rate cuts rather than rate rises in the US, and this could provide a further boost for equities.
As well as hedging US equity exposure in the belief it has become too overvalued, the investment team at River and Mercantile Solutions has also been adding to emerging markets and small caps.
“While large cap US stocks look a little stretched, parts of the world are trading on a discount,” Saunders said. “Smaller companies broadly look attractive, while emerging markets are also a good option.”
The team uses the River and Mercantile FOURcast investment model to help determine their exposures to different markets. A forecasting tool, it breaks the market in to four phases – Upward re-rating, Downturn, Apprehension and Stable – based on a variety of macro factors.
Saunders said FOURcast was currently indicating a “stable” phase, during which the team believes it is time to be invested in equities as credit conditions are improving, economic signals are broadly positive and valuations are fair.
Emerging markets in particular are flagging as attractive amid a further stimulus drive from China, sparked in part by the US trade war.
“China stimulus and the return of emerging market growth are the new positives for emerging markets broadly, and we think China will stimulate even further now as a result of the trade war, so that is creating a lot of potential broadly for emerging markets, particularly in Asia,” Saunders said.