Home Business Markets are in no-man’s land

Markets are in no-man’s land


Longer-dated US government bond yields – a strong indication of how investors view the direction of longer-term economic growth – have receded from 3.5% in mid-June to 3% today. This suggests bond markets have shifted from the first half focus of keeping pace with interest rates.

Now, it is more concerned with pricing in the impact of slower economic growth, resultant from tighter monetary policy in developed economies, slower growth in China, and war in Ukraine – as well as the possibility of a global recession. And while investors are hoping for a turning point on inflation, there is little evidence it is close to being tamed.

Deep Dive: Russia is not the only European equities story

Markets are in a sort of no-man’s land, given the limited extent this deteriorating macroeconomic backdrop has been captured in earnings expectations, and the lack of evidence investor sentiment shows signs of capitulation. After all, while valuations are generally cheaper at present, unexpected profit warnings would see them fall further.

In this environment, investors can deploy several tactics to help protect portfolios.

Low valuations provide protection

Equity markets this year have faced twin headwinds of a reversal of their economic prospects and the pricking of a valuation bubble, particularly centred on the technology sector. Entering the year, equity markets became exceedingly polarised between a very expensive top 20% of companies compared to a bottom 20% that did not look that expensive in the context of historic valuations over the last 20 years.

Reflecting this greater cyclicality, this latter group has now fallen to attractive valuation levels that should compensate long-term investors prepared to look through the current economic uncertainty. While the top 20% of companies has fallen considerably, valuations remain high and investors have not yet thrown in the towel. Year-to-date, an equity allocation centred around low cyclically adjusted valuations has proven a defensive strategy, and we expect this to continue.

Counter cyclicality is king

Investors could also gain exposure to counter-cyclical sectors to ensure greater portfolio resilience. The challenge is finding areas of the market where this is not already reflected in valuations and that deliver a reasonable level of income.

One counter-cyclical sector we are currently optimistic on is student housing. Typically, a greater number of people opt to study amid a recession in the hope the labour market will be more favourable when they graduate.

World Bank warns rising rates threaten global recession

Additionally, the sector seems due a post-pandemic rebound, after many students chose to remain at home or postpone studying altogether when Covid-19 shuttered lecture theatres, pubs and clubs. Student housing is also underpinned by a number of structural growth drivers, including the steady increase of student numbers and improvement in the quality of student housing stock.

Find robust fundamentals

Student housing is not the only area we see opportunity. Several attractively valued sectors from a historical perspective are supported by powerful structural tailwinds, and contain innovative businesses with robust fundamentals.

Many biotechnology companies are trading at particularly cheap valuations, despite the space being underpinned by highly resilient growth fundamentals. An ageing population, along with less developed countries demanding better access to healthcare, should drive strong long-term demand for the sector’s products.

These drivers are resilient and broadly unaffected by macroeconomic conditions, fuelling an expansive runway for growth. Moreover, numerous high-profile acquisitions have recently completed in the sector, delivered at considerable premiums.

Private equity is also compelling, with several trusts in the space trading at 40% discounts to their net asset value. These discounts have widened considerably since early 2022 following concerns around valuation and leverage.

Typically, these buyout funds invest in stable, well managed and highly cash generative businesses – those best placed to deliver strong relative performance amid uncertainty. However, they have seen their share prices fall in sympathy with private, venture capital funds, where valuations have collapsed, companies remain unprofitable, and follow-on funding is a real concern.

US retail sales rise an unexpected 0.3% in August

Cash in hand

Given the rebound in markets from their recent lows, we have increased the cash level in our funds to just over 3%, which should provide ample flexibility to act on compelling opportunities as they arise.

In raising cash levels, we sold or trimmed a number of holdings we felt had performed extremely strongly year-to-date. We trimmed our holding in JLEN Environmental Assets Group, which invests in renewable energy infrastructure.

While there are limited signs pressures on gas prices will recede near term, we have taken some profits as the net asset valuation and its premium have risen.

Philip Matthews is co-portfolio manager of the TB Wise Multi-Asset Income fund



Previous articleBackstedt storms to junior women’s time trial title at road world championships | Cycling Road World Championships
Next articleMeta’s privacy obligations may be added to German antitrust probe, court adviser says By Reuters