- With headwinds looming, our sample of asset manager outlooks shows a drastic reversal in sentiment
- We look at the markets suddenly out of favour, and those now in from the cold
The BlackRock Investment Institute’s decision to name its 2022 mid-year outlook “Back to a volatile future” seems justified enough. Inflation, tighter monetary policy and geopolitical ructions have all culminated in a punishing year for investors so far, and the institute sees further challenges ahead. “We ultimately expect central banks to live with inflation, but only after stalling growth,” it notes. “The result? Persistent inflation amid sharp and short swings in economic activity. We stay pro equities on a strategic horizon but are now underweight in the short run.”
This is just one of the asset manager outlooks we parse each half year as a gauge of how professional investment groups are positioning, but that paragraph does give a good sense of how the mood has shifted since our last assessment. At the start of 2022 we noted that our sample of fund firms had tended to make positive noises on some of the biggest equity markets, if also pointing to threats such as inflation and rising interest rates. Much of the lingering positivity on stock markets has since evaporated – although a couple of specific areas have in fact seen an improvement in sentiment. And as always, this is just an indicator of how certain asset managers are viewing the market, and could even be seen as a set of contrarian signals for the adventurous sort.
No time for cheer
What’s notable this time is just how sharply fund firms have turned away from the markets that were most popular at the start of the year. That’s certainly the case for the leading equity region: just 25 per cent of our sample is now positive on the US, down from an overwhelming 80 per cent at the start of 2021. Some 37.5 per cent are now neutral towards the region, with the same proportion taking a negative stance.
A sourness towards the former market leader could be down to a number of factors, from the ferocity of this year’s sell-off to the aggressive pace of monetary tightening, all of which are interlinked. To return to the BlackRock Investment Institute, which has shifted from a positive stance at the start of the year to being underweight US equities, it argues that the Federal Reserve intends to “raise rates into restrictive territory” – emphasising that the big worry is now in many ways recession rather than inflation. While the group adds that this is partly reflected in the sell-off of 2022, it cautions valuations have not yet come down enough to reflect weaker earnings at US companies.
That bearish mood has carried across to other areas previously seen as a potential recovery story. Three-quarters of the sample were positive on Japan at the start of the year, with some citing the nation’s continuation of easy monetary policy in contrast to other developed market countries. And yet global problems appeared to have taken over, with just a quarter of our current sample still overweight and half in neutral territory. JPMorgan’s multi-asset team, which moved from positive to negative over the period, warned that slowing growth could be a headwind for cyclical markets such as Japan, although yen weakness may prove a relief “unless (or until) the Bank of Japan quits quantitative easing”.
In another area the wilting away of enthusiasm likely has more to do with region-specific issues. Often an unloved region even in the good times, Europe has moved firmly out of favour this year. Three-quarters of the sample have taken a negative view, with not a single firm adopting a bullish stance. With the ongoing war in Ukraine, an energy crisis looming, and European economies and companies coming under severe pressure, there’s an argument that the share price weakness seen already this year has further to run.
Elsewhere the shift is less dramatic. Positivity towards the UK has slipped away slightly, perhaps echoing some investor concerns that a market buoyed by commodity exposure could see its tailwinds ease off over time. But there has not been a wholesale shift here.
Yet there are some unloved regions which have moved back into favour somewhat. Sentiment has thawed very slightly on both Asia and the emerging markets within our sample, and while some groups split China out as a standalone region, certain firms believe an easing of pain in the world’s second-biggest economy could make for a brighter second half.
Take Fidelity’s multi-asset team, which notes that economic metrics offer some hope after a difficult time. As they put it: “Economic activity monitors in China show that the worst is likely to be over.” That would certainly be a relief for investors who have endured another Covid-related slowdown and the volatility induced by the 2021 regulatory crackdown.
Some of this has arguably started to be priced in: it should be noted that the dedicated China trusts no longer look quite as 'cheap' as they did fairly recently, relative to their own history. A number, such as Fidelity China Special Situations (FCSS) still see their shares trade on a wider discount to net asset value than the 12-month average, but on a notably tighter discount than the peak of that same period.
Tables turn for bond investors
With the end of 2021 dominated by inflation concerns and the threat of monetary tightening, an unsurprisingly unloved asset at the turn of the year was the government bond. That caution has looked well justified, with such bonds selling off in tandem with equities since then. The yield on a 10-year US Treasury, which moves inversely to the bond’s price, has moved from around 1.5 per cent at the start of 2022 to above 3 per cent in the late spring before falling back a little more recently. In the UK, 10-year gilt yields have had a similar trajectory from a lower base.
But a combination of higher yields and recession concerns have lured some investors back into government bonds, if tentatively so. That shift in sentiment can be seen from our own sample: 70 per cent were negative on government bonds at the start of 2022, but now a slightly higher proportion than that has adopted a neutral view. If not an overwhelming endorsement, it’s a sign that government bonds are no longer almost universally seen as an asset to entirely avoid. In a similar move, some 62.5 per cent of our sample is now positive on investment grade corporate bonds – the same proportion that was negative on the subsector at the start of this year.
On the other hand, we can see sentiment weakening notably on high-yield bonds, which are more resistant to interest rate changes but vulnerable to economic downturns and the corresponding risk of companies defaulting on their debt. After many years of strong returns, a majority of our sample has taken a negative view on high yield for the time being, and more could join them if economic conditions deteriorate further. As we’ve said before, investors who use strategic bond funds – which typically load up on corporate and high-yield debt – would do well to see exactly which areas of the fixed income universe are best represented in their chosen portfolio.