US funds sector review – record rate rises, recession fears and the road to stability

In June, the US Federal Reserve (Fed) tightened monetary policy by raising interest rates by 0.75% to reach a range of 1.5-1.75%. It’s the biggest interest rate rise by the bank in nearly 30 years and the third separate hike so far this year.

Interest rate rises increase the rewards for savers looking to earn interest on their cash, but make it more expensive for consumers and businesses to borrow money. Central banks raise interest rates when they want to take the heat out of an economy and reduce demand. They have to balance this with the risk of going too far and slowing growth to the point of tipping the economy into recession. 

Under the surface

It’s worth drilling down a bit beneath the headline 8.6% level of inflation. Just one fifth of the sectors in the core Consumer Price Index (CPI) basket are experiencing inflation at or below the Fed’s target of 2%, compared to around 55% before the Covid-19 pandemic.

Fed Chair Jerome Powell has been clear that the bank sees gaining control of inflation as essential to stabilising the economy. But not all the drivers of the higher inflation are within the bank’s control. The ongoing uncertainty and supply chain disruptions caused by Russia’s invasion of Ukraine, for example, also adds complexity.

It’s difficult to predict how well the US economy will handle these challenges. The labour market is holding up well, with unemployment sitting at 3.6%, though it’s expected to rise from here. We’ve seen some well-known businesses like Tesla, Uber and Amazon share plans to either reduce their workforce or slow the rate they’re hiring at.

A challenging market

The US is home to lots of large world-leading businesses that dominate their industries. But this hasn’t stopped the market struggling with a number of headwinds this year.

As the Fed has tightened conditions, stocks priced largely on expected higher cashflows far into the future have fallen out of favour, sending their valuations downwards. While this has been a trend for much of the year, more recently, it’s been a renewed driving force behind the market decline.

Some economists are estimating a 35% chance of a recession in the US. In an environment where the economy could be weaker, more defensive companies in sectors with more stable earnings could hold up better. This could include sectors like consumer staples, utilities and healthcare.

The financial health of the US consumer will continue to be key in determining how well the US economy does. After all, consumer spending makes up around 70% of the US economy.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice.

How have the US Wealth Shortlist funds performed?

The strongest performer out of our Wealth Shortlist selections over the last year has been the Legal & General US Index fund, gaining 8.84%*. This was marginally behind the FTSE USA Index, which returned 10.13%. Past performance isn’t a guide to future returns.

The fund uses a full replication approach, which means it aims to invest in every company in the FTSE USA Index and in the same proportions. Despite this, tracking errors can occur, meaning the fund delivers a different return to the index.

Over the long term, we expect its return to fall behind the index rather than be ahead. That’s because of the costs involved in running the strategy, like taxes and dealing charges.

The weakest performer over the past year was the Baillie Gifford American fund. Over the last year, the fund hasn’t performed as well as the FTSE USA Index or the IA North America peer group average.

More recently the managers’ growth-focused investment style has fallen out of favour with investors. That’s mainly because of inflation and interest rate expectations rising. Investors have been less willing to pay up for companies with high growth potential, which has seen stock prices of some the fund’s investments fall significantly.

This underperformance is something we’ve discussed with Bailie Gifford. You can find out more in our our April update on the fund.

Although short-term volatility can feel uncomfortable, we think investors should focus on the longer term. This fund aims to perform better than its benchmark over a five-year period, although this isn’t guaranteed. But the fund’s style means performance can look quite different over shorter periods.

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.

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. Investments will rise and fall in value, meaning you could get back less than you invest.

Past performance is not a guide to the future. Source: *Lipper IM, to 31/05/2022.

Past performance is not a guide to the future. Source: Lipper IM, to 31/05/2022.

Find out more about Legal & General US index including charges

Legal & General US index Key Investor Information

Find out more about Baillie Gifford American including charges

Baillie Gifford American Key Investor Information

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Our fund research is for investors who understand the risks of investing and that investing in 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.