Investors in global equities should not fear the spectre of rising interest rates as market fundamentals remain supportive of developed market stocks, according to fund managers such as Liontrust’s John Husselbee and Invesco Perpetual’s Simon Clinch.
For several years concern has been raised among investors that an increase in interest rates in the US and UK from their current historic lows would deal a swift blow to markets when announced.
Just the hint that it might happen has been enough to knock back investor sentiment on several occasions in the past few years and prompt significant market falls, with an implied worry that when it actually happens, panic will ensue across many markets.
In what is perhaps the most widely anticipated central bank meeting in history, next month’s gathering of the rate-setting Federal Open Markets Committee is when many were expecting a capitulation point from the Federal Reserve.
However, thanks to Black Monday’s sell-off on the back of sharply slowing Chinese growth many commentators are now expecting a greater hiatus of the tilt to a rising rate environment, says IG market analyst David Madden.
“The events of the past week have led traders to believe that interest rates will not rise in the US next month … dealers are now not so sure if there will even be a rate rise this year,” he said.
Performance of indices since August sell off
Source: FE Analytics
“The phrase ‘dead-cat-bounce’ has been bandied about … unless we have a fresh round of buying then the rally will unravel. This week traders have been tricked into buying up cheap stocks thinking the correction is here to stay, only to have their fingers burnt,” Madden added.
“The markets are very sheepish at the moment and everyone is waiting for someone else to make the first move.”
Husselbee, head of multi-asset at Liontrust, says an environment of low sentiment will most likely continue but should be supportive of markets rather than a curse.
“Investor optimism has now vanished and a consensus seems to be forming that a US interest rate rise at next month’s Fed meeting, which had previously been seen very roughly as a 50/50 call, would now be a big mistake,” he says
“We have seen a number of ‘risk‐off’ episodes in markets since the global financial crisis and from
the evidence we have seen thus far, this just represents another one, although we acknowledge that investor sentiment may take some time to recover this time.”
But Husselbee says that while this has added to confusion around the timing of the move, the sheer worry in the market surrounding it in the run-up means a rally is possible when the central bank finally makes its first hike.
“We still think that the first US rate hike will be the most influential driver of asset pricing this year (or next). Whether the Fed hikes in September – which now seems doubtful – or at a later date, the move will be positive for markets,” he said.
“It has been anticipated so keenly and for so long that there is little prospect of investors adopting a more long‐term view until this hurdle has been cleared.”
“There is no cause for panic: the global economy continues to grow modestly with most leading indicators in the US and Europe suggesting further expansion, and this is compensating for weakness in China and other emerging markets.”
Simon Clinch, manager of the £420m Invesco Perpetual US Equity fund, suspects that greater volatility is likely as the rate rise comes close but argues that it could lead to rising share prices in some areas, such as US financials.
“In reality, we believe the more important view is that the odds of rates being higher in a year are extremely high. And markets agree, [there is a] more than 90 per cent probability. The friction between volatile short-term and more stable longer-term predictions creates significant opportunity for us as long-term investors,” he added.
“US banks have faced seven years of earnings headwinds from low interest rates and in my view stand to benefit significantly in a higher rate environment. The stocks have a tendency to whip around with short-term expectations of when rates will start rising, which is what one might expect if valuations in the sector were uncomfortably high.”
However, the manager says valuations in sectors like US banks are in fact attractive following the sell-off and general weakness this year and that over the longer term there should be a return of sentiment.
“The 10 largest financial stocks are trading at relative trailing P/E ratios near their all-time lows, despite the fact that a major headwind to returns is likely to be lifted in the next year. Whether this happens this quarter, next quarter or the quarter afterwards won’t matter,” he said.
“Current valuations imply a significant under-appreciation for the longer-term earnings power of these businesses, which is why we view the short-term volatility as a gift.”
“The US equity market is highly efficient at pricing in current information, but in our view fails to account for the longer term. This is the opportunity that, in my view, cries out for exploitation.”
