Dan Farmer

Questions over US dollar’s status seem premature

• While the US’ standing as the world’s largest and deepest capital market is not remotely under threat, disorder and disruption coming out of Washington is causing investor disquiet. This in part stems from the gap between institutional investors’ economic orthodoxy versus a US administration whose economic philosophy is hard to pin down, beyond characterising it as ‘transactional.’
• Ideally, investors want pro-market policies featuring fiscal restraint, action to curb galloping public debt, light-touch regulation, free trade, and low taxes.
• Instead, despite generating lots of headlines, Elon Musk’s Department of Government Efficiency (DOGE), which initially targeted an extremely ambitious US$2 trillion in government spending cuts, then downgraded to targeting US$1 trillion savings, now claims just US$160 billion in savings. The figure hardly moves the needle in the direction of fiscal restraint against annual US federal government spending of around US$6.8 trillion.
• Moreover, US government spending in the first 100 days of President Trump’s second administration has jumped 10% compared to the same period in the previous year. Then, of course, there is uncertainty from the back and forth on tariffs, as well as apprehension over potentially unfunded tax cuts.
• All up, you have a cocktail that is inducing investor apprehension showing up, amongst other things, in US dollar weakness, albeit still short term, with the greenback estimated to have lost around 10% of its value since Inauguration Day.
• US dollar weakness is striking because countries that impose tariffs usually see their currency rise. However, the untidy rollout of the administration’s tariff plans has bewildered investors and a general lack of transparency in terms of motivations have led to a sense of financial markets unease.

Threats to US equity market exceptionalism

• Markets are cyclical, and the US has not always dominated and so it is possible that share market leadership may flip from the US to the rest of the world, as it has done in the past.
• The most recent period of US stock market outperformance has been supported by positive economic and financial drivers, but these may be vulnerable to shifting macroeconomic forces and geopolitical risks.
• Since mid-2008, the S&P 500 has beaten the MSCI EAFE Index (this index measures the performance of large and mid-cap companies across developed markets countries, excluding the US and Canada), by a sizable margin, delivering average annual returns of 11.9% versus 3.6% through December 2024.
• Over the same period, the S&P 500 grew earnings four times faster than MSCI EAFE and boasted price-to-earnings (P/E) multiple expansion of 12.8x to 21.7x, compared to the MSCI EAFE’s expansion of 11.3x to 14.0x.
• Using return on equity (ROE) as a measure of how efficient companies are with their equity capital, the S&P 500 has maintained a higher ROE than the MSCI EAFE Index since June 2008, and that spread has widened over time. Currently, ROE for the US market is 19% versus 12% for EAFE.
• We think several factors have driven that difference, including US technological innovation, more efficient operations and shareholder-friendly government policies, such as corporate tax cuts.
• The combination of higher earnings growth and ROE have led investors to place a higher P/E multiple on the US equity market. At the start of 2025, the US stock market premium versus EAFE on a forward P/E basis was hovering at 55%, near its all-time high, although recent market volatility has narrowed the gap.
• In this context, it’s easy to see how the booming tech sector has contributed to US earnings growth and multiple expansion.

What may cause shift in market leadership?

• US share market exceptionalism has been a powerful trend, but it is arguable that risks, especially in the tech sector, are rising.
• Investors expect US earnings to keep growing but for US outperformance to persist, US company earnings will have to grow faster than those outside the US.
• As robotics and artificial intelligence emerge as the latest sources of technological advancement and economic growth, the US boasts leadership in these arenas, notwithstanding ripples created by DeepSeek.

By Dan Farmer, Chief Investment Officer​

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Dan Farmer

Changing sources of inflation

While inflation remains far too high, the sources of inflation have changed.

Global supply chains are no longer overwhelmed by surging demand for goods, nor disrupted by COVID-19.

Think back to the first half of last year; there were stories of strong demand for everything from furniture to games consoles. Demand for these items and other goods has cooled.

Remember the global microchip shortage that was frustrating so many industries last year? That has eased too.

The oil price today is lower than before Russia’s invasion of Ukraine.

So, why is inflation providing to be so sticky?

The main source of inflation now is in service industries, which are more exposed to labour costs. In the US, Britain, Canada, and New Zealand, for example, wages are still growing with the need for labour still strong – six of the G7 group of big rich countries are currently enjoying an unemployment rate at or close to the lowest seen this century.^[1]

It is hard to see how underlying inflation can meaningfully ease while labour markets are so strong. So households, businesses, and investors are likely going to have to navigate further interest rate rises and the accompanying complications and hardships.

Central Banks to the rescue?

Over the past few decades, investors became accustomed to central banks coming to the rescue by cutting official interest rates to give financial markets a boost when things got jittery.

This time, though, it is hard to imagine. Commentary from the Fed, as well as other major central banks, including the Reserve Bank of Australia, suggests that official interest rates will keep rising until inflation is brought under control.

Wishful thinking — seen in events like the very strong start to January across many share markets, on the back of investors appearing to have temporarily convinced themselves that the rate rising cycle was nearing an end — is unlikely to alter central banks’ inflation fighting, interest raising course.

The thing about inflation is that it is difficult to haul back once it gathers a head of steam as we saw when the Fed’s preferred inflation gauge rose again in January, the fastest pace since June last year.

Read the report.

By Dan Farmer, Chief Investment Officer

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[1] Unemployment Rates, OECD – Updated: February 2023. https://www.oecd.org/newsroom/unemployment-rates-oecd-update-february-2023.htm

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Dan Farmer

IOOF, one of the largest financial services groups in Australia, announced yesterday that IOOF Investments have appointed Mercer Australia as their asset consultant.

The appointment brings together IOOF’s high-calibre and award-winning investment management team with Mercer’s global scale and 40 years’ experience providing professional investment advisory services to institutional investors.

Dan Farmer, IOOF Chief Investment Officer, commented “The appointment allows our highly experienced portfolio managers to leverage the strength of Mercer’s deep global and local manager research, their market insights and sophisticated systems in determining long-term strategic asset allocations, and holistic approach to dynamic asset allocation to support the team in the delivery of strong performance outcomes to our clients.”

“Mercer has a solid fit to our existing investment methodologies and provides another layer of competitive advantage to our robust multi-manager investment approach.”

Luke Fitzgerald, Mercer’s Wealth Management Leader in the Pacific Market, said “We’re delighted to be working with IOOF. As an extension of the IOOF Investment team, Mercer will bring a different kind of perspective and true global capability to support IOOF in delivering on their clients’ needs.”

Prior to Mercer, IOOF’s asset consultant was Russell Investments (Russell). At the end of 2016 Russell notified IOOF that they wished to end their consulting business to focus on implemented consulting and asset management solutions. As agreed, Russell continued providing IOOF with consulting advice up until 30 June allowing a new provider to be selected and implemented to ensure continuity of cover.

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Dan Farmer

According to IOOF, in the current low return environment, clients are putting pressure on fees while still seeking returns above the benchmark.

Fund managers have responded with new lower-cost products and investment strategies, including smart-beta.

The rise of ‘smart-beta’

Smart-beta are quantitative based strategies that seek to outperform traditional market cap indexes such as the traditional S&P/ASX Index. Unlike traditional indices, smart-beta strategies aim to tilt to underlying building blocks of share returns such as momentum, volatility, or value – breaking the link with market cap as the criteria for investment.

Dan Farmer, IOOF portfolio manager – Australian Equities, says smart-beta strategies aim to provide the best of both active and passive investing. “This allows a fund to deliver returns above benchmark indices, but thanks to objective, rules-based methodology, at lower costs than a pure active fund,” Dan says.

While smart-beta portfolios can theoretically be built on any fundamental measure, deciding which ones will deliver a premium to traditional benchmark indices can be a little trickier. This is where factor investing can help. Factor investing is a sub-set of fundamental analysis which aims to systematically capture attractive characteristics such as value or momentum and therefore deliver higher returns. While these factors can be diverse, commonly they are: value, size, momentum, low volatility, term and credit.

In the world of factor investing, these factors stand out because indices based on these six measures have historically earned returns in excess of market-cap weighted indices.

Dan says this neither surprising nor a well-kept secret for some factors. “Factors such as value have long been used when constructing share portfolios.”

Other measures are a little more surprising. Higher volatility, for example, is commonly associated with higher returns but less volatile shares have delivered higher returns over the longer term.

Implementing a factor strategy

In October Adviser News we looked at the challenges – and importance – of periodically rebalancing client portfolios. Factor investing, where some fundamental analysis is required, adds another level of complexity to portfolio rebalancing.

Dan says factor investing isn’t a simple buy and hold strategy and it makes sense for advisers to access this strategy through professionally managed funds, such as IOOF MultiSeries.

“Fund managers are doing the hard work by constructing, and rebalancing, both single factor and multi-factor funds,” Dan says. “Advisers can concentrate on asset allocation, which is the main driver of returns in a diversified portfolio.”

Factor investing and risk

Factor investing should be considered in conjunction with a client’s tolerance for risk and volatility.

Just like the asset classes they are derived from, factor returns are cyclical and different factors have clear periods of underperformance. For example, momentum investing traditionally outperforms in bull markets, whereas low-volatility is a more beneficial approach in flat or declining markets

”Factor investing can be an important risk mitigation strategy, while keeping fees under control,” Dan says, “at the same time, proactively moving between factors can offer excess returns while maintaining a diversified portfolio.”

“Factor based funds can be used to keep the risk, and cost, in line with the client’s appetite.”

The prospect of lower fees for similar returns to those achieved by fully-active managers is enticing. There are however, many different considerations – from risk to portfolio management, costs and more – when deciding whether factor investing is right for your clients.

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