Equity markets have had a testing time this year, caught as they are between the optimism of improvements in the UK and in the US, and the pessimism of a faltering recovery in Japan, a clear slowdown in China, the emerging markets crises, and tensions between Russia and the West over the fate of Ukraine.
Further, just as last year’s ‘taper tantrums’ led to elevated levels of volatility, so this year’s game of ‘will they, won’t they raise interest rates?’ is testing investors’ steel. Markets demand clarity and the current nature of central bank forward guidance teeters from one policy decision to another, creating uncertainty.
While we have seen huge levels of volatility, the markets have moved broadly sideways year to date. However, there has been a savage sector and leadership change and within this there has been a clear trend: a move from growth to value stocks with a particularly heavy sell-off in technology and biotech companies.
We are long-term bulls and optimistic about the outlook for 2014. We expect developed market equities and corporate bonds to outperform emerging markets equities and government bonds on the back of improving economic growth and still benign liquidity.
However, we are cautious over the shorter term. At the end of 2013, we became concerned markets were approaching fair value and would struggle to move significantly higher unless companies could improve on their tepid earnings growth. Recently, we have started to see just such a recovery in positive earnings surprises in the US.
When markets are at this point there is a smaller margin for error: investors become less forgiving, and changes in economic conditions become of greater concern. If this year follows the pattern of the past four years, we can expect a near-term market correction and a summer of discontent, followed by a strong rally into the close of the year.
Security selection is paramount and for us that means attractively priced companies that can translate improved macroeconomic conditions into top line revenue and bottom line earnings growth. We further favour companies with strong balance sheets, good returns on capital and management teams focused on improving returns to shareholders.
We are currently positioned in companies we believe can survive a market correction. We find these in low beta sectors – those with a low correlation to market movements – including utilities, energy, consumer staples, healthcare and telecoms services.
We are looking for companies that should participate in a late-year rally with a view to adding them to client portfolios over the summer months as market dips provide attractive entry points. These companies are generally to be found in sectors that are mean-reverting or have an aggressive beta. They include financials, information technology, industrials, consumer discretionary and materials.
Volatility haunts the investor psyche and periods of high volatility – such as we have seen over the past quarter – raise investors’ concerns about the safety of their assets. But market volatility need not be an indicator or driver of portfolio volatility.
Nancy Curtin is chief investment officer at Close Brothers Asset Management