- Stock market 'haves' and 'have nots'
- Neutralise different types of bond risk
'Santa rally' is a phrase you’re bound to have come across many times already this Christmas and, regardless of whether one happens in 2023 or not, seasonality is definitely a thing for markets.
This year, moderating inflation and slowing economies means the pressure is building on central bankers to turn dovish on interest rates. At the same time, there are tentative signs in much of the West that the slowdown may be softer than many had predicted. But this is far from a Goldilocks scenario: China’s puncturing debt bubble may yet have more serious consequences and, despite a delicate thaw in Sino-US relations, Taiwan’s 2024 election, to say nothing of the US's own, could see the diplomatic temperature plummet.
At this point in the 2020s, geopolitical crises are more like familiar circling vultures than unknown black swans. Iran’s proxies firing one missile too close to a US asset, or Vladimir Putin’s forces making a breakthrough in Ukraine, are the sort of terrible but non-remote probabilities that could send financial markets into a tailspin.
Yet it is the level of uncertainty, both good and bad, that brings about the pricing of opportunity for investors who, by definition, must look to better times. After all, if you believe the end is nigh, why forego any of today’s spending power at all? Those who blend innate optimism with a pinch of cynicism may, therefore, be licking their lips.
To return to the Christmas theme, another yuletide tradition is asset managers’ new year outlooks and, this time around, there is reason to be particularly interested.
Asset managers never wish to push a full-on gloom narrative, but their positive views are worth examining this year. In light of all the uncertainty, and a monetary policy regime that even if it softens won’t return to the overflowing punch bowl seen pre-2022, experts now trumpeting active portfolio management are singing for their supper.
Strategy sub-categories
Elite money managers have their own spin on things, and their portfolios range from top-down macro strategies, those exploiting disconnects in relative value between asset classes, to a focus on event-driven opportunities, and hedging equity market movements. Intuitively, today’s delicate balance of geopolitics, shifting fiscal and monetary regimes, technological disruption and valuations, suggest all four broad areas are in play. So are several popular tactics beneath the surface
Macro strategies operate in equity, debt, commodity and currency markets, playing on variables and economic trends. Indeed, one of the key themes in BlackRock Investment Institute’s 2024 outlook is the emerging new regime in which macro events have a greater influence, and in which market volatility is triggered by interest rate policy and tighter financial conditions. The onus is on managing rather than avoiding risk, however: “We think investors should seek to neutralize macro exposures or – if they have high conviction – be deliberate about which exposures they take.”
One of BlackRock's most assertive strategy calls is on the usefulness of partial allocations to index-linked government bonds (linkers), especially in the US. Based on a belief that long-run inflation could stubbornly stay above 3 per cent (most central bankers target 2 per cent), the logic of the trade works if the rest of the market eventually settles on the new higher equilibrium, ie long-term inflation expectations are raised. If that does happen – an outcome that would temper renewed impetus for fast-paced rate hikes – price risk is more likely to be tolerable, given the coupon element of the return is protected from inflation.
Either way, inflation is still likely to be more volatile than in the past. So, returning to the theme of balancing and neutralising risks, BlackRock’s overall strategic preference is for bonds with a shorter time to maturity and hence lower duration (price sensitivity to interest rates).
Looking to equities, stock market returns in 2023 were dominated by the Magnificent Seven tech stocks in the US, which perfectly illustrates what could become a durable theme of dispersion in returns. While being slightly underweight developed equity markets generally, BlackRock notes the potential for further positive surprises driven by the artificial intelligence mega theme.
Of the major markets, Japan is the only equity region where BlackRock advocates an overweight position. Stock buybacks here amplify the benefits of a generally strong earnings trend.
Granularity could be the ticket in many markets, however. At a time when companies around the world are dealing with potentially weaker demand for their products, higher input costs, trickier supply chains, tax pressures and expensive borrowing, stark contrasts could emerge beyond the inexorable march of big tech and the rest. Stock selection, therefore, should focus on the durability and strength of earnings. As we wrote last week, this translates into a view that stockpicking may shine again next year.
Some businesses will navigate challenges better than others and, although the ‘return of value investing’ has suffered false starts in the past, overlooked companies beating a path to recovery could reward shareholders. And markets may price the sorts of risk premium that optimists struggle to resist, particularly if interest rates moderate.
