Positioning for a new market regime

With financial markets remaining turbulent, which sectors and asset classes present opportunities for an unconstrained multi-asset strategy?

• Rising interest rates, global growth concerns and a less accommodative monetary-policy backdrop highlight the need for careful consideration not just of individual companies but also of thematic trends.
• We are placing greater emphasis on more defensive businesses, including pharmaceuticals.
• Other areas of interest from a thematic perspective include renewables and infrastructure, although it is vital to consider valuations carefully.
• Select commodities also hold appeal as near-term beneficiaries of supply constraints, while copper is an area of secular growth.

Rising interest rates, global growth concerns and a less accommodative monetary-policy backdrop do not optically create a positive cocktail for global equity markets. Indeed, rising bond yields over the last six months have already caused significant collateral damage, with many of the former Covid beneficiaries in the large-cap technology area falling precipitously from their heady heights, feeding through to a wave of cost-cutting. The ripple effects have spread wider, with the spotlight further cast on those companies that are yet to turn a profit, erstwhile dependent on their rising stock prices to fund operations and growth, as well as to attract talent from a tight labour market pool.

While it is not our base case that we will experience a full-scale liquidity event, such developments in the tech sector are concerning. They put the spotlight on the need for a discerning approach to stock picking and the requirement for careful consideration not just of individual companies but also of thematic trends. This marries a full understanding of a business’s fundamentals and stock characteristics with long-term thematic trends such as an ageing population and the influence of big government.

A global thematic approach has been espoused by Newton since its foundation in 1978, and themes are viewed as providing a more meaningful lens to consider opportunities than traditional sectors. Similarly, a crude geographic classification based on where a company is quoted can be misleading in terms of understanding where the true risk exposure of holdings lies. For instance, while at first glance the European exposure of the equity portion of our Real Return portfolios may appear substantial, the picture looks quite different on a revenue basis, evidencing the limitations of traditional methods of ‘slicing and dicing’ portfolios.

Turning back to themes, while the common thread of these tends to be the ability to capture long-term trends, their relevance over discrete periods is undoubtedly influenced by shorter-term forces and the market cycle itself. For example, we are currently experiencing a period of heightened volatility in markets, exacerbated by geopolitical turmoil, intense inflationary pressures, and the decision of central banks to rein back easy monetary conditions by initiating quantitative tightening (reducing their balance sheets by selling assets).

Equities: a different tilt

We believe this ‘regime change’ necessitates a different tilt to equity positioning, with increased emphasis placed on more defensive businesses and a pivot away from long-duration stocks which are vulnerable to rising bond yields. We favour sectors such as health care, including traditional pharmaceutical companies focused on addressing long-term conditions such as cancer, Alzheimer’s and diabetes. There is also recovery potential in areas such as cardiac and eye surgery, given the reduction in the number of elective procedures during the Covid-19 pandemic.

Other areas of interest from a thematic perspective include renewables and infrastructure which, as well as displaying steady, predictable cash flows, have the added role of gaining exposure to long-term projects where cash flows are inflation-linked. We are mindful that there has been a rush to invest in those assets which offer strong ‘green’ credentials, so it is vital to consider valuations carefully.

Considering commodities

Commodities also hold appeal, but here we believe it is important to be highly selective. While the travails of the major oil companies have been well-publicised, and their transition plans to champion greener energy sources are in the spotlight, we acknowledge that it is likely to be a bumpy ride as scrutiny intensifies around the speed with which they embark on a net-zero path. There is scope for their inclusion in Real Return portfolios as near-term beneficiaries of oil-price buoyancy, aided by the supply constraints created by Russian oil embargoes, although we would want to see meaningful progress made towards energy transition over the longer term, and indeed society is increasingly likely to demand this.

Elsewhere within the commodity spectrum, copper is an area of secular growth, underpinned by near-term supply shortages and the move towards the deployment of renewable generation, the adoption of electric vehicles (the metal is an essential component), and the migration to 5G mobile networks.

In summary, despite the challenges of the febrile backdrop, characterised by short-lived equity market rallies giving way to a resumption of a risk-off tone in markets, we contend that this remains fertile ground to fine-tune portfolios as we seek to ensure they are well-placed for the next phase of markets. Ranking securities by their risk contribution is revealing in this regard, to help ensure that the amount of risk taken is commensurate with our level of conviction.

We maintain a wish list of securities and remain ready to try to take advantage of thematic drivers such as a growth in capital expenditure by companies as the economy emerges from the pandemic, combined with an increase in consumer experiences as activities such as travel resume. While we remain in cautious mode at this juncture, we are deploying our analytical resources to the full to take advantage both of valuation opportunities and the varying fortunes of disparate business models.

Authors

Catherine Doyle

Investment specialist