19 Jan 2023
January saw the New Year start with investors hoping for less febrile markets than 2022 produced and after a year of multiple unexpected events, investors will be hoping for a return to some level of normality for the global economy with supply chain pressures continuing to ease on the manufacturing side and bottle necks dissipating. While no one knows exactly what lies ahead over any 12-month period, history does tell us that since 1928 there have only been four periods when the US stock market has fallen for two consecutive years, so hopefully history will be on the side of investors in 2023.
My first visit of 2023 saw a quieter London than late 2022 with the normal January blues likely to be impacted further by the cost of living squeeze affecting most UK households.
It was not just equities that had a torrid 2022 with bond markets suffering their worst setback for many decades as the Fed increased interest rates at a rapid pace. Most investors expect bonds to act as a counterbalance to equities in a portfolio, but in a year of rising inflationary pressures and supply side shocks, bonds were no hedge against equity market declines, seeing sharp falls themselves in capital values as investors repriced financial assets to a structurally higher level of interest rates than has occurred in the post GFC period.
After the setback to fixed interest markets it was an opportune time to meet Mike Riddell who manages the Allianz Strategic Bond Fund - a macro driven fund. Mike believes that central banks across the developed world were too slow to recognise inflationary pressures and got very ‘behind the curve’ in terms of raising interest rates. The Russia/Ukraine conflict added extra inflationary pressures to a global economy which was, with hindsight, over stimulated in the latter days of the Covid-19 pandemic. Mike believes that with growth slowing, inflation will fall quickly - an example being gas prices in Europe that have fallen 75% from their August highs. With interest rate hikes having a 12-month lag before impacting on economic activity, Mike believes that further economic slowdown is a certainty and he is very cautious on real estate prices across the globe. US house prices are declining at the rate of roughly 1% each month and he believes that residential prices in the UK could fall by 15-20%. Mike argues that the business cycle is driven by interest rates. Housing is likely to be the first sector affected, followed by manufacturing and lastly the labour market which is generally the final major part of an economy to be hit. As a result, Mike is very positive on the prospects of recovery for government bonds in 2023.
The financial services sector in the UK has now expanded outside the old ‘Square Mile’ into areas such as Canary Wharf and parts of London with a more industrial heritage such as the Smithfield and Old Bailey areas. The street outside follows the route of the ancient wall around the City of London which was part of the fortification’s bailey, hence the metonymic name. The current main building block was completed in 1902 and is a Grade II listed building. This is where major criminal cases within Greater London and serious cases from other parts of England and Wales are heard. The Old Bailey originally adjoined Newgate Prison until its closure in 1902 where hangings were a public spectacle in the street outside until May 1868. The present building co-occupies the site of the demolished prison. On the dome stands the court’s symbolic gilt bronze statue of lady justice holding a sword in her right hand and scales of justice in her left. Much of this area now houses new office space and Baring Asset Management have moved from their old offices near Liverpool Street to a purpose-built office in this area. There I met up with Nick Williams who has managed the Barings Europe Select Trust since the mid-2000s.
The fund follows a proven philosophy of growth at a reasonable price and was hit in the value rotation in the early part of 2022 but has seen a significant recovery since the second half of last year. The focus is on higher quality smaller companies which are seeing improved earnings revisions, better business models, higher margins and higher return on capital employed. After the setback to European markets and with sentiment being so negative on the asset class, there are now a number of very attractive valuations available in European smaller companies and Nick believes that the GDP outlook for Europe is more balanced and not as bleak as people might think. He also believes that interest rates will peak at a much lower level than some investors fear. There is a strong bias to the larger end of small caps so the fund is highly liquid. Some of the new purchases for the fund in the final quarter of 2022 included: Puma, the German consumer goods company, Swiss wealth manager Julius Baer, and HelloFresh in Germany. A number of financial stocks that are benefitting from higher interest rates feature in the top 10 holdings including Banca Generali in Italy, ASR Nederland, an insurance business, and Fineco Bank in Italy. ASR Nederland trades only on a forward PE of around 8x and is a $8bn market cap company. Elis, the French listed industrial laundry company and the biggest in the world in this sector, is also a top 10 holding and trades on a PE of 12-13x. Europe is a market currently out of favour, with small companies being particularly hard hit in the last couple of years and subsequently offering interesting valuation opportunities for longer-term investors.
Emerging markets have had a difficult decade due to the strength of the US economy and in 2022 the rise in the US currency hit returns in this area as monetary conditions tightened in the developing world. The prospects for emerging markets over the next five years look a lot more favourable, as many of their central banks pre-emptively raised interest rates to head off inflationary pressures and some parts of the developing world may be able to cut rates later in 2023. Some countries and regions are also commodity exporters which has ripple through effects to their wider economies (through better terms of trade) and, unlike in the developed world, there is not a shortage of labour. While inflation is higher than historic levels in many of these countries, it has not risen as dramatically compared to historic levels as in the developed world.
I met up with James Syme and Ada Chan who manage, along with Paul Wimborne, the JOHCM Global Emerging Market Opportunities Fund, which takes a top-down approach to managing equities in the region, believing country effects are key drivers of investor returns. While investors often focus on Asia, Latin America, with multiple economies commodity exporters, could see good economic recovery this year. Mexico has benefitted from US economic strength and remittances and is strong in the sectors where US labour shortages are noticeable, including hospitality and construction. In Brazil, the BCP raised rates aggressively with inflation now coming back under control. Favoured names in Brazil include Ambev, Banco Bradesco, together with Azul airline and pulp and paper company Suzano. In Mexico, Banorte in the banking sector and consumer staple retailer Walmart de Mexico are favoured names, together with the construction sector Cemex.
Within Asia, Indonesia is an overweight and has benefitted from good politics and the exposure of its economy to in-demand commodities including nickel, oil and gas and edible oils. As a result, it is seeing strong exports and a current account surplus which will help domestic demand over the medium term. Banks and consumer names are favoured, including Bank Mandiri which is focused on the corporate lending market and Bank Rakyat which is at the low end of consumer loans, including micro finance. The fund is also overweight the UAE and while a lot of EMEA is difficult, this part of the world is performing well with the Gulf region benefitting not just from a high oil and gas price, but also from an influx of Russian money into the region. Fertiglobe makes fertiliser from natural gas, has a fixed rate on its gas purchases and is also making green ammonia for exports, so there is an ESG story element in the stock. The managers have also become more positive on China with the end of the zero Covid-19 policy and believe the leadership are now focused on delivering growing prosperity to a wider proportion of the population than has occurred over the past decade, promoting home grown businesses and culture.
Stocks held in China tie in with the common prosperity theme including Proya Cosmetics, a domestic ‘A’ share, Tsingtao Brewery which again is a domestic brand benefitting from greater levels of consumption and premiumisation by consumers and travel businesses such as platform Trip.com and Travelsky which receives payment on every airline booking. And in real estate, China Resources Land which, as an SOE can continue to borrow cheaply and can acquire cheap assets from highly leveraged private developers.
All in all, the managers are expecting a much more buoyant period from emerging markets after the pull back in valuations and now improved economic fundamentals than has been seen in the last few years.
RSMR provides impartial, qualitative, forward-looking research for advice businesses.
Click here to head to the RSMR blog for market updates and a whole host of informative, up-to-the-minute content.
Click here to sign up to RSMR research where you can access RSMR fund ratings, fund profiles, factsheets, insights, market updates and event information.
This information is for UK Professional Advisers only and should not be given to retail clients.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
Rayner Spencer Mills Research Limited is a limited company registered in England and Wales under Company Registration Number 5227656. Registered office: Number 20, Ryefield Business Park, Belton Road, Silsden, BD20 0EE. RSMR is a registered trademark.