On any count, it’s not an easy time to be an investor. Elevated inflation and a worsening economic outlook are competing for our attention, with UK Consumer Price Index inflation hitting a 40-year high of 9 per cent last month and the Bank of England warning of a recession on the horizon. This is particularly bad news for cash savings. While the Bank has raised its rate to 1 per cent, recession risk, and excessive corporate and national debt, make it likely that inflation could sit persistently above interest rates for a while yet.
So what are investors to do? Peter Spiller, manager of Capital Gearing Trust (CGT) which has a wealth preservation focus, said that he has become "much more active in seeking out assets that can protect shareholders against inflation". This has led to Capital Gearing trust having a higher allocation to asset classes such as property and infrastructure.
Among property investments, he likes "beds, meds and sheds" owing to their propensity for index-linked long-term contracts with credit worthy companies. However, he also notes that the one thing that would be bad for property would be a significant rise in real interest rates. Similarly, infrastructure trusts would suffer with higher interest rates, but a rise in power prices creates a tailwind for the net asset value of renewable energy investment trusts.
Spiller is "pretty bearish" on equities generally, but sees opportunity among companies in the energy and mining sectors. He thinks that even though prices have fallen by a fifth this year, valuations of S&P 500 index companies are still “very rich”. He also says that a tolerance of monopolies and a reduction of income going to labour are now mean reverting, with governments much more sympathetic towards labour, leading to a modest outlook for corporate profits.
But that doesn’t mean there aren’t still bargains to be found in the US. I was pleasantly surprised by how bullish the general atmosphere was at the London Value Investor Conference last week, where a host of investors presented their investment process and various stock ideas. One of the headline speakers was legendary investor Joel Greenblatt, author of The Little Book that Beats the Market and co-chief investment officer of Gotham Funds.
He said that for the past 30 years, he’s screened the largest 1,400 companies in the US, picked out the half which are the cheapest on a free cash flow basis and then created a portfolio of about 300 stocks. On the morning of the conference last week, he said that his portfolio was in the 92nd percentile towards cheap according to Gotham's interpretation of the free cash flow yield for these companies, with an average of over 30 per cent.
“When we’ve been here in the past things look pretty ugly [and] you increasingly get these things cheap because you can’t really think of [a] much worse macro environment,” he acknowledged.
But when stocks are cheap it’s always because investors are fearful and the important thing to look at is how things played out. Greenblatt says that the last time his portfolio was in the 92nd percentile towards cheap according to his screening, it rose 60 per cent in the following two years.
His data says that the S&P 500 is currently in the 22nd percentile towards expensive. History suggests that two-year forward returns from this level have averaged 13 per cent, which is why he believes that the opportunity is much better among value stocks and the disparity of his expectations for a deep value portfolio versus a growth portfolio are historically large.
Of course, highly cyclical companies are vulnerable in recessions. But they are also where some of the most attractive pockets of value can be found. Investors must remain vigilant as growth is becoming harder to achieve, but there are always some parts of the market that will do well.