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Abrdn’s Day: Why I’m moving out of the UK and Europe for the US

29 November 2022

The investment manager switched from a risk-facing approach to a defensive stance in 2022, slashing exposure from the UK and Europe.

By Tom Aylott,

Reporter, Trustnet

The US market is a “bellwether through financial storms,” according to Jason Day, senior investment manager at abrdn, who has decided to cut exposure to the UK and Europe in favour of the States.

Day manages five portfolios for the asset management group and entered the year with a risk-facing strategy.

However, he tilted his stance to become more defensive after central bank rate hikes were more severe than anticipated, cutting his exposure to equities in favour of US sovereign bonds.

He said: “As the backdrop deteriorated and the Fed appeared more hawkish, we've had to react to that and been very busy making a lot of changes. The direction of travel has been in dialling down risk.”

Day started by cutting exposure to European equities in February when “the trajectory of rate hikes was going to be a lot steeper than anticipated”. As such he has dropped his exposure 17 percentage points since the start of the year down to 8.4%.

The European market is dominated by industrials and other cyclical sectors, which are most vulnerable to high inflation and interest rates, according to Day.

He said: “We decided that we had to a go underweight Europe, and we've been making that cut deeper as we've gone through the year because the recessionary outlook for Europe and European companies is really bad.”

The invasion of Ukraine has only made forecasts for the region worse, with the Eurozone reliant on Russia for 40% of its natural gases and around a third of its crude oil.

This will continue to be a significant challenge in future, with Day adding: “That was clearly a problem and that problem has only escalated since.”

Equities overall were reduced to 88.8% of the portfolio throughout the year, which included also trimming the UK overweight down to a neutral 27.7%.

Despite the poor outlook for the UK, Day said that the region still deserved some exposure within his portfolios.

“We debated recently about reducing our UK exposure further, but we decided to keep it where it is,” he said. “Although economically there are some very dark storm clouds, the structure of the FTSE All Share is quite resilient in this type of environment,” said Day.

“It's going to be quite murky for some time, and we've actually brought forward our recession forecasts to the second quarter of next year from the end of next year. We're well below consensus in terms of growth estimates going forward.”

Unlike Europe, the UK’s dominant ‘old-economy sectors such as financials and mining could provide portfolios with some resilience throughout turbulent markets, and at a decent price.

Day said: “The UK is very cheap – it’s cheaper than emerging markets and it's cheaper than the Eurozone. The old economy construct is very value oriented, and you probably want that in this kind of environment. Structurally, we think it's still a useful part of the portfolio relative to other parts of the world.”

However, the UK’s low unemployment levels means that inflation is potentially embedded, with the upcoming recession perhaps being the worst in 100 years. Day said that it might not be as damaging as the 2008 financial crisis, but it’s likely to last longer.

The US is tackling similar issues of low unemployment and persistent inflation, but the crucial difference is that consumer confidence is still strong.

Mortgage rates have had a significant effect on the juxtaposition of US and UK consumers – homeowners in the US are locked into long-term mortgages of around 30 years, whereas UK consumers use fixed rate mortgages varying from around three to five years, making them far more sensitive to interest rate hikes.

Day said: “You've got similar structural issues, but I would argue that the mortgage market is the key differential which makes things more difficult for the UK consumer.”

Indeed, share prices in the US have declined in 2022, but this has been driven by investor sentiment as opposed to poor performance.

Day said: “US profits have actually been pretty reasonable this year. There’s still a lot of growth for corporates, so it’s not been a complete disaster.”

At the same time, the durability of US revenues also makes Day “quite cautious” about a potential drop in earnings, which could be a shock to the US and global economy.

Consumer confidence has been resilient so far, but the Federal Reserve (Fed) is engineering a slow down with its interest rate hikes which could put people off spending.

“There are a number of things to keep watching on the dashboard and we're not seeing major cracks yet, but you know, but growth will be harder to achieve from here,” Day said.

Although the US maintains a dominant position of 41.6% within Day’s portfolios, he skimmed his allocation to the region by 4 percentage points throughout the year, instead favouring sovereign bonds.

With more rate hikes expected from the Fed moving forward, Jonathan Simon, manager of the JPMorgan American Investment trust, said that “volatility will no doubt persist until we get more clarity on the inflation picture”.

With value continuing to outperform this year, he said that those investing in the US will have to diversify their portfolios with a mixture of both growth and value names.

Simon said: “We expect this relay to continue, and so for investors this means that having a balanced portfolio which integrates both approaches may be more attractive than ever – particularly for those focused on the long term.”

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