Investors should prepare for more short-term pain, with the recent re-pricing seen in global equity markets set to continue, according to Janus Henderson's Paul O’Connor.
After a year of serene progress for stock markets all across the world in 2017, this year has seen a marked change. The first three-quarters of 2018 saw US stocks power ahead on the back of strong economic growth aided by President Donald Trump’s tax reforms.
In the fourth quarter to 26 November, however, we have seen a broad correction in all regions. A broad sweep across the world in Morningstar Direct shows the MSCI World, the leading developed market index, has declined 8.46% in US dollar terms in the quarter. Meanwhile, the MSCI EM Index is down 6.8%, and the MSCI Frontier Markets Index 2.47% lower.
And some stock pickers have seen pockets of value crop up on their screens. However, many have held off from dipping their toes into the water so far.
O’Connor, head of Janus Henderson's UK-based multi-asset team, is one of them. True, valuations in general are lower now than before, but they haven’t quite moved enough yet to call the end to the re-pricing cycle: “I don’t think valuation signals are that strong to say that there’s great value here. It’s looking a bit better, but it’s not compelling.”
On sentiment and positioning, meanwhile, it’s the same story: “We’ve moved from complacency to caution. We haven’t moved from complacency to absolute panic, which is where you’d want to buy things.”
There are a couple of positive surprises that could change O’Connor’s view and potentially entice him into calling an end to the re-pricing environment.
One of those would be the market getting a sense the Fed was closer to being finished in its interest rate hiking cycle. The second would be a suggestion that trade concerns were either peaking, or a “path to de-escalation” was laid out clearly.
“They’re, for me, the two paths to reviving risk appetite in the shorter term,” says O’Connor. How far away they are, though, is another question.
But there are some specific areas of attractive value he has seen. The first of those is emerging market debt, which he added to his funds in the summer.
Buying the FTSE 100
Probably the biggest change in asset allocation this year, though, has been a sizeable move towards investing in UK equities. Specifically, in the FTSE 100. In fact, claims O’Connor, the UK is now potentially the only place in the world that is attractive on an absolute basis, not just on relative terms.
“In those two areas we felt that there had been enough of a re-pricing and that sentiment, positioning and valuation had moved enough,” he adds.
Clearly, we’ve seen sentiment and positioning towards UK equities at depressed levels on a global basis, with Brexit uncertainty leading many investors to shy away from taking big bets on the asset class. That’s led to even more depressed valuations.
O’Connor first bought exposure to the FTSE 100 after the fall in the first quarter, at which time the index was down around 8%. In the intervening six months, the blue-chip index rallied 9%. However, in the quarter to 26 November, it’s back down 6%. That gave O’Connor a chance to top up his holding, which he’s done in the past couple of weeks.
The appeals of the FTSE 100 are numerous. The first being that rotating out of the US – the most moved market – and into the UK – the most loathed market – is “a contrarian positive”. Second, the yield of 4.8%, with many stocks in the index paying much higher than that, is attractive.
Finally, the composition of the FTSE 100 is one that “normally works well late in the economic cycle”. “The UK has a lot of defensive names, a lot of commodities, and typically these things do quite well late in the cycle.”
