LONDON (Reuters) - Global investors are considering European and emerging market assets to safeguard themselves from further turbulence in U.S. equities and bonds as persistent inflation causes wagers on the timetable of Federal Reserve interest rate reduction to be revised.
April was a disaster on Wall Street, with the S&P 500 share index and U.S. Treasuries posting their greatest monthly loss since September.
Money managers are now searching for methods to limit losses if the trend does not reverse.
That could entail the restructuring of portfolios that had been elevated for years by richly-valued U.S. equities, said Sonja Laud, CIO at Legal & General Investment Management, which manages approximately $1.5 trillion.
"Diversification will be a lot more important going forward," she said, adding that LGIM was not expecting superior returns from global equities but now preferred European assets to those from the United States.
Amelie Derambure, senior multi-asset manager at Amundi, Europe's largest asset manager, said she still expected long-term gains from U.S. equities but had bought put options to defend against a 10% decline. She had also shifted some funds out of Treasuries into euro zone bonds.
The S&P 500 fell 4.2% in April.
Enter Europe
U.S. stocks have provided about 80% of the price return of the MSCI World share index since 2020 in dollar terms, Pictet Asset Management calculates
The "Magnificent Seven" group of tech equities, propelled by an artificial intelligence surge, contributed over 60% of the S&P's total return last year.
But as persistent inflation propels expectations that the Fed will hold U.S. borrowing costs at a 23-year high of 5.25%-5.5% or even raise again, the cost of wagering on long-term gains from big tech's substantial AI investments versus holding cash is rising.
A steep decline in Facebook owner Meta's shares in April highlighted the risks of expecting for stellar tech earnings in an environment where rates remain elevated. Until recently, markets had expected the Fed to start reducing in June.
The S&P remains highly valued, with a price-to-earnings multiple almost 7 percentage points above Europe's Stoxx 600, LSEG data reveals.
Investors said the Stoxx appealed because it is loaded with companies in so-called value sectors such as finance and energy which benefit from stable global development but tend not to suffer when financing costs increase.
"We are increasing exposure to Europe," said Luca Paolini, chief strategist at Pictet Asset Management. "The general macro outlook is supportive for a cheap, cyclical value market."
European fund manager Carmignac reduced some U.S. tech holdings in April and was pursuing opportunities closer to home, the group's director of cross-asset Frederic Leroux said.
"Diversifying towards Europe today makes a lot of sense," he said. "Each time you have a new wave of (U.S.) inflation you will see a big outperformance for Europe."
Moderating euro zone inflation implies the European Central Bank is expected to start reducing interest rates on June 6.
Ross Yarrow, managing director for U.S. equities at investment bank Baird, said global investors were mostly negative on towards U.S. stocks on valuation grounds.
But superior revenue growth also helped Wall Street outpace Europe in 12 of the past 16 years, he said.
Treasury Bears
An index of Treasury bonds, declined around 2% in April, its worst month since September.
Amundi's Derambure said she still expected Fed cuts but had loaded up on euro zone government bonds in recent weeks to wait "for this washout in U.S. fixed income to be over".
Traders expect 35 bps of U.S. rate cuts this year but 65 bps in the euro zone, where inflation has fallen closer to the ECB's 2% target.
According to Barclays strategists, Treasuries may not rally even when the Fed does cut because of high and expanding U.S. government debt.
Emerging market bonds are gathering up purchasers, however, as investors expect to see robust economic development in the likes of India, Indonesia and Vietnam.
LGIM's Laud added that she was positive on Indian bonds, which have been snatched up by foreign investors ahead of inclusion in a key debt index later this year and as the economy grows.
"Within fixed income we see the best opportunities from a risk perspective (from) dollar-based emerging market debt," Manulife's chief investment officer for multi-asset solutions Nathan Thooft said.
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Tangled
Diversifying from U.S. assets could be difficult.
The Stoxx tends to monitor the S&P, with an 88% correlation between the two markets since 1986, Baird's Yarrow calculates.
Treasuries also significantly influence other debt markets, with a 1 percentage point rise in 10-year U.S. yields commonly driving global yields 56 basis points higher, a Barclays study found.
"It is always very difficult to say, OK I want to be lighter on the U.S. and investing more in other parts of the world," said Carmignac's Leroux.
"But even with correlations, you have moments where you can find outperformance somewhere else."