US funds sector review – interest rate cuts on the way?

Federal Reserve (Fed) Governor Chistopher Waller recently set out a potential path for interest rates being cut sooner than expected.

There’s always been concerns that if the Fed raises rates too high or leaves them higher for too long, it could impact the country’s economic growth. The US market is expected to grow just 1.5% in 2024, well below emerging economies.

Except for some recent wobbles, the US economy has been extremely resilient for the most part. In particular, consumers are still spending their savings. This had fuelled talk that interest rates would stay higher for longer. An idea that investors were only just getting to grips with.

Now with interest rates potentially being cut because of lowering inflation (i.e. not because of recession) and headline inflation on a steady downward trend since its 2022 peak, the consensus might be changing.

Some investors even think rates could be cut as early as June next year. US inflation came in at 3.2% in October, still above the Fed’s 2% target, but moving in the right direction.

Are small-caps the place to be?

The S&P 500 is trading close to fair value, except for the ‘magnificent seven’ (Apple, Alphabet, Google, Microsoft, Nvidia, Meta, Tesla). These have been leading the market and trading at premium compared to others.

But smaller companies have been unloved in 2023 and are currently trading at a steep discount compared to their large-cap peers.

With economic growth slowing and a recession still on the table, historically, small-caps have tended to perform worse than large-caps in this type of environment. This has been the case throughout 2023.

However, with the chance of a soft-landing rising and the huge difference in valuations, this could be a great entry point. Especially considering small-caps also tend to rebound quicker after a recession.

Presidential primaries are just round the corner

The fourth of the likely five republican primary debates takes place this month. The first states voting on who they want to represent their party in the next election starts in January. Looking at the current polls, it looks like we’re set for a Biden Trump rematch.

Despite not attending any debates so far, Trump’s lead in the republican primary has been widening with an estimated 58% of the votes. Ron DeSantis whose approval rating has been on steady decline is running second with an estimated 13% of votes.

The margin of lead Biden holds in the democrat primary is even wider. The current president is estimated to have close to two thirds of the votes with Marianne Williamson next best with an estimated 7%.

Biden has always been the likely winner, but his chances increased even more after Robert Kennedy Jr dropped out of the Democrat race to run independently.

How have the US Wealth Shortlist funds performed?

Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

This article isn’t advice. Investments and any income they produce will rise and fall in value, meaning you could get back less than you invest. If you’re not sure if an investment is right for you, ask for financial advice. Remember, past performance isn’t a guide to the future.

For more details on each fund and its risks, you can use the links to their factsheets and key investor information below.

The strongest performer of our Wealth Shortlist US funds over the last year was Baillie Gifford American.

The fund rose 24.59%* over the past year, outperforming the IA North American sector average. Performance was helped by the fund's ‘growth’ style of investing coming into favour in 2023.

The fund had a difficult 2022 as interest rate rises and spiralling inflation prompted investors to move away from stocks with high growth potential. But with the consensus that rates have peaked and inflation falling, several economic indicators show that maybe the economy is cooling off.

There are hopes that interest rates will soon be cut and this could be a tailwind for growth investors.

The fund also holds several stocks who could benefit from the advancements in artificial intelligence (AI). Investors have taken a view that AI will help businesses become more efficient and offer better customer service. And so far, we’ve seen a number of these companies’ share prices skyrocket this year.

The fund aims to outperform its benchmark over five-year periods, with a concentrated portfolio including some exposure to smaller companies. Both factors increase risk. The fund’s significant growth focus can also lead to periods of volatility.

The weakest performer over the past 12 months was Artemis US Smaller Companies, returning -5.37%.

Although the fund did outperform the Russell 2000 index which returned -8.34%, it marginally underperformed the IA North America Smaller Companies sector average which returned -5.05%.

The fund can have a concentrated portfolio, including exposure to smaller companies. Both of these factors increase risk.

The fund’s struggled in the first half of the year with high interest rates and high inflation hurting its growth style of investing. During times of heightened economic uncertainty, smaller companies tend to underperform their large cap-peers which has been the case for this year.

The fund also suffered following the US regional banking crisis earlier in the year after the collapse of Silicon Valley Bank and the rescue of First Republic by JPMorgan Chase. A few of the financial sector companies owned in the fund were sold after regional banks showed signs of weakness.

We don’t expect all the funds on the Wealth Shortlist to perform in the same way. We think it’s important for investors to build a portfolio filled with managers who have different approaches and investing styles to help generate long-term returns.