Stock-specific risks and global macroeconomic headwinds are set to remain a challenge for investors throughout 2016, according to FE Alpha Manager Leigh Harrison (pictured). 
The head of equities, Europe at Columbia Threadneedle therefore thinks that active management and stock selection is more important than ever as investing in broader markets will no longer provide attractive returns.
Over the last year or so, markets have been bruised by fears surrounding China’s growth slowdown, the collapse in commodity price and more recently, the concern that central banks are no longer able to manipulate the current economic cycle.
Markets across the globe are therefore down since the start of 2016, with the FTSE 100 providing a loss of 10.12 per cent to-date.
Performance of indices in 2016
Source: FE Analytics
Some investors believe that this slump is mostly the result of negative sentiment and crowd psychology as opposed to genuine headwinds, with Trevor Greetham explaining earlier today that many market issues have been blown out of proportion, including the negative impact that oil and China have had.
“China is pursuing global deflation. It’s been slowing down for three or four years pushing commodity prices lower, and as a result you’ve had global disinflation. Also, they’ve recently been devaluing their currency slightly and that’s added to that global disinflation pressure,” he said.
“It’s not a dramatic move and when we look at the Chinese data we don’t think it’s as bad as people have been saying.”
However, Harrison says that highly active managers in 2015 came out on top because they were able to avoid sectors such as mining and energy, and he says that macro issues will continue to force investors to tread carefully.
“Concerns about China will continue into 2016, as the slowdown there is a multi-year phenomenon. This will pose further challenges for the mining companies and other commodity-related firms,” he warned.
The manager adds that stock-specific risks have also reared their heads over the last few months, with the likes of auto manufacturing company VW and Glencore running into trouble and plummeting in their valuations.
Performance of stock over 1yr
Source: FE Analytics
Because of this tricky environment, Harrison says that investors can no longer rely on the comfort blanket of QE to boost asset prices and will have to forage for individual holdings to achieve positive results.
“We think that investors will have to work very hard to find ‘winners’, as organic growth is likely to be very scarce in 2016, but equally investors will need to make sure that they avoid company-specific disappointments,” he said.
“2016 is likely to represent a transition point for the global economy as the US Federal Reserve raises interest rates from extremely low levels. Such transition points are usually accompanied by a pick-up in volatility, and that is why we are relatively cautious about the outlook.”
In terms of China, the manager says that authorities will find it challenging to minimise the impacts of the growth slowdown and, in the meantime, companies are likely to try to export as much of their products as possible which will then create a tough pricing environment and weigh heavily on companies’ earnings.
He adds that the credit boom experienced in China will also have to be dealt with by authorities and is likely to have a significant impact on market behaviour this year.
“Concerns that China could further devalue its currency may cause some uncertainty, which is likely to be unhelpful for stock markets,” Harrison continued.
“We’ve already seen the adverse effects of China’s slowdown on companies that produce equipment for the mining industry, but now the weakness is spreading out to other industrials.”
“Indeed, some analysts are talking about a recession in industrial profits. This is not the same thing as an economic recession, but it does show that the environment for some companies is extremely difficult.”
Another factor that has arguably been overshadowed by other headwinds is geopolitical risk, and the manager believes that this issues surrounding terrorism and extremism will play more of a role in market behaviour as we continue through 2016. He says that this, combined with this year’s US presidential election, are further reasons to expect heightened volatility and lacklustre market performances over the course of the year.
On a more positive note, though, Harrison says technology continues to advance more and more rapidly, and areas of the market that focus on lowering emissions and reducing pollution could come to the fore this year.
This is perhaps more relevant than ever, following the VW emissions scandal publicising the need for cleaner and more efficient energy use and applying pressure on other auto manufacturers to tighten their emissions requirements.
“Technology is changing at a rapid pace and affecting industries in a manner that few of us would have been able to anticipate just two or three years ago,” the manager explained.
“Unfortunately, assessing the impact of technological change is far from straightforward; ‘killer’ and ground-breaking technologies will emerge, but there will also be failures, and it is difficult to identify these with certainty.”
“Moreover, there may be longer-term dynamics – such as the advent of self-driving cars – which will change industries in a manner that is very hard to judge accurately. For example, self-driving cars won’t just affect car manufacturers, but a whole raft of associated industries such as electronic and safety equipment manufacturers, battery and power supply manufacturers and insurers.”
Another trend for investors to look out for, according to Harrison, is sentiment surrounding climate change, which is already proving to be a heavy burden on coal industry stocks due to legislation changes and a general reluctance to hold miners due to collapsing commodity prices.
“Of course, some of the companies that will change the investment landscape in the future won’t be investable for equity investors yet – a lot of them are start-ups and not traded on any stock exchange,” he said.
“However, there will be opportunities, as well as winners and losers as the process of change occurs. This is where an active and selective investment approach can make a difference, in our view.”
Leigh Harrison co-manages three funds in the IA UK All Companies sector, the Threadneedle UK Equity Alpha Income portfolio and Threadneedle UK Equities, a SICAV domiciled in Luxembourg.
Since the turn of the century, the FE Alpha Manager has almost doubled his peer group composite with an average total return of 166.87 per cent.
Performance of Harrison vs composite since 2000
Source: FE Analytics
