Global Investors around the world are rethinking their strategies as Wall Street’s turbulence and stubborn inflation lead to a recalibration of expectations for U.S. Federal Reserve interest rates. April was a rough month for U.S. stocks and bonds, with the S&P 500 share index and U.S. Treasuries experiencing their most significant monthly losses since September. As a result, money managers are increasingly looking towards European and emerging market assets to mitigate risk and find more stable returns.
Seeking Stability in European Assets
The shakeup on Wall Street has caused investors to consider diversifying their portfolios. Sonja Laud, Chief Investment Officer at Legal & General Investment Management (LGIM), which manages about $1.5 trillion in assets, indicated that diversification will be crucial in the coming period. Laud noted that while global stocks might not provide superior returns, European shares offer more value than those from the U.S. Amelie Derambure, senior multi-asset manager at Amundi, Europe’s largest asset manager, echoes this sentiment. She has purchased put options to protect against a potential 10% drop in U.S. stocks and moved some cash from Treasuries into eurozone bonds.
The S&P 500 experienced a 4.2% drop in April, highlighting the need for alternative investment avenues. Despite this downturn, the U.S. stock market has historically provided about 80% of the price return for the MSCI World share index since 2020. However, as inflation remains sticky and the Federal Reserve maintains borrowing costs at a 23-year high, the cost of holding cash has become more appealing relative to long-term gains from U.S. equities.
European Value Stocks and Emerging Market Bonds
European shares are gaining favor due to their value-oriented sectors like banking and energy, which tend to perform well during steady global growth but aren’t as affected by rising borrowing costs. The Stoxx 600, Europe’s leading index, has a lower price-to-earnings multiple than the S&P 500, making it a more attractive option for investors seeking value.
European fund manager Carmignac has reduced some U.S. tech holdings and is looking for opportunities closer to home. The group’s head of cross-asset, Frederic Leroux, stated that diversifying toward Europe makes sense, especially given the anticipation that the European Central Bank (ECB) might start cutting interest rates in June.
Emerging market bonds are also drawing attention from investors. With countries like India, Indonesia, and Vietnam experiencing robust economic growth, these bonds offer a potential hedge against U.S. market volatility. LGIM’s Laud is optimistic about Indian bonds, which have seen increased foreign investment ahead of their inclusion in a major debt index later this year.
Challenges in Diversifying
Diversifying away from U.S. assets isn’t without its challenges. The Stoxx 600 tends to track the S&P 500 closely, with an 88% correlation between the two markets since 1986. This correlation can limit the benefits of diversification, as market movements in the U.S. often influence European markets. Similarly, Treasuries have a strong impact on other global debt markets. A one percentage point rise in 10-year U.S. yields can pull global yields 56 basis points higher, according to a study by Barclays.
Despite these challenges, Carmignac’s Leroux believes that moments of outperformance can still be found in global markets. This sentiment is shared by other investment managers, who are carefully restructuring their portfolios to minimize risk and capitalize on emerging opportunities outside the U.S.
Conclusion
As Wall Street navigates a turbulent period marked by stubborn inflation and uncertainty around Federal Reserve policy, global investors are diversifying their portfolios to find shelter from the storm. European value stocks and emerging market bonds are gaining traction as alternative investment avenues, offering potential stability amidst the chaos. However, the strong correlation between U.S. assets and other global markets poses a challenge, requiring investors to carefully balance their portfolios to mitigate risk while seeking new opportunities.