US market may turn up more opportunities than just AI

Advisers looking to gain exposure to US equities for clients, can choose from a relatively small selection of ETFs and managed funds that target the market specifically.

US equities accounted for more than 70% of the MSCI World ex Australia Index as at July 31 and its top constituents were all technology stocks, including the so-called magnificent seven AI-related stocks which have boomed this year.

The latter’s gains and hopes of a softer economic landing than previously anticipated, are likely behind recent strong interest in US shares from Australian investors.

US equity ETFs and global share funds dominated the list of the most traded ETFs by AUSIEX clients in July; accounting for five of the top 10 products either bought or sold by advisers.

How to best position portfolios

“The US market rally this year has been unusually concentrated as an attribution analysis reveals that the returns on only seven companies are responsible for approximately three quarters of this year's gains,” wrote Morningstar’s chief US market strategist, David Sekera, in a third-quarter market outlook on 26 June. “Many market commentators are saying this rally marks the start of a new bull market and investors should jump into equities to ride this wave, but others argue it’s a bull trap in an ongoing bear market and investors should get out of stocks while the getting is good.”

Perhaps the answer to this conundrum is not a wholesale change of tack, but instead a reconsideration of the stocks that might provide advisers and clients with exposure to the most likely gains in US markets moving forward.

“The question for investors isn’t whether to raise the sails and ride the tailwind of a new bull market, or to batten down the hatches in preparation for a near-term squall, but rather how to best position their portfolios based on today’s valuations,” Sekera said.

“At the beginning of the year, we advocated for a barbell-shaped portfolio consisting of overweight positions in the value and growth categories and underweight core. At this point, with the growth category near fair value and the value category still significantly undervalued, we are now advocating an underweight position in both growth and core and remain overweight in value.”

What's on offer

The vehicles for implementing a chosen position are varied. US equity funds available in Australia include large ETFs such as iShare’s S&P500 ETF (ASX: IVV), Vanguard’s US Total Market Shares Index ETF (ASX: VTF) and the SPDR S&P500 ETF (ASX: SPY).

Others allow investors to target specific sectors or strategies, including Betashares’ S&P 500 Equal Weight ETF (ASX: QUS), iShares’ S&P Small-Cap ETF (ASX:IJR) and the VanEck Morningstar Wide Moat ETF (ASX: MOAT).

For AI’s true believers, Betashares offers a NASDAQ 100 ETF (ASX: NDQ) and Global X has similar products.

It is worth noting, though, that a global equity ETF, benchmarked to the MSCI World ex Australia Index, provides significant exposure to these stocks plus geographical diversification via the 30% of its assets invested in other countries, said Justin Walsh, Morningstar’s Associate Director of Manager Research in Australia.

Cautionary outlook

The general outlook for US stocks still requires a degree of caution, according to analysts at Principal Asset Management, who wrote in its Midyear Perspective that the headline double-digit returns for the S&P500 so far this year “mask much more anemic market conditions under the surface”.

“This environment warrants a degree of caution among equity investors in the near terms, but also has created numerous and relative value and rebalancing opportunities across the capitalisation spectrums, sectors and regions,” they said.

Outside artificial intelligence, nearly all other sectors “have delivered low single-digit returns at best. Interest rates sensitive sectors; financials, real estate and utilities, remain in negative territory as it might be expected amid tight credit conditions.”

While noting that most stocks remain in bear territory, especially small and mid-caps, Principal also pointed to the potential opportunities that may arise as the year plays out.

“Many of these companies have already priced in a high degree of recession risk and have adjusted to tighter credit conditions and therefore, seemingly offer compelling relative valuation and recovery opportunities,” its analysts said.

“They are likely less susceptible to future cyclical volatility or further rate hikes, especially compared to the handful of long-duration growth mega-caps that have dominated.”

The upshot is there’s a great deal more to the US market’s recent gains than meets the eye and that advisers would do well to consider both its depth and the diversity of products which gain access to it.