Investors should be wary of buying into trends following the recent rise in markets as fundamentals remain largely unchanged, says FE Alpha Manager Sebastian Lyon.
The manager of Troy Asset Management’s three crown-rated Trojan fund says changing market sentiment had seen previously shunned sectors surge in popularity.
“Markets are taking a great deal on trust,” he said. “Since bond yields troughed in the summer, rotation has been less about bonds into equities and more about a savage change of leadership within equity markets in anticipation of reflation.”
“Much of this has been driven by short covering and momentum buying,” he added.
Performance of fund vs sector and index since launch
Source: FE Analytics
“There is certainly little evidence of any material pick-up in earnings, rather a lack of further falls – the so-called second derivative. Investors seem to have been hasty in embracing Trumpflation.
“The trend is your friend until it isn’t. Momentum investing is not an approach we would ever embrace at Troy.
Lyon continued: “Febrile risk-on markets have a tendency to be powerful and short-lived. Since the launch of the Trojan fund in 2001, we have experienced a number of such rotations leading to relative (not absolute) short-term underperformance.”
“These periods occurred in 2003, 2009 and 2013 and all lasted six months. Stock market sentiment indicators are at bullish extremes.”
Lyon said following trends could see investors storing up poor performance in years to come and could leave a lot of attractive investment opportunities undervalued.
He said: “Acting upon the fear of losing out by chasing winners is an almost certain way to lock-in poor future performance.
“On the contrary, we are hopeful that the rush to buy into reflation plays will leave some high quality businesses that we favour left behind.
“Rising stock markets have not changed the fundamentals. Valuations remain very high and increasing debt has obfuscated the underlying fragility of markets.”
Reflecting on performance of the Troy stable last year, Lyon said the funds had made “steady progress with characteristically and reassuringly low volatility”.
“A solid half was somewhat offset (at least on a relative basis) by the market euphoria in the second half of the year,” he said.
“This year has started on a more positive trajectory thank last; a lot of good news is already discounted by the markets.”
Performance of Troy funds in 2016
Source: FE Analytics
The best performing Troy fund of 2016 was the Electric & General Investment fund, which rose by 20.53 per cent. Strong returns were also recorded by the Troy Spectrum and Trojan Global Equity fund, both returning more than 19 per cent.
Looking at the political themes of 2016, Lyon says the rise of populist politics had “placed austerity in abeyance”, noting deficit targets were being torn up despite record levels of debt.
The FE Alpha Manager noted that the election of Donald Trump as US president was a “shift away from the erstwhile post-financial crisis consensus”.
“Since the financial crisis politicians have delegated economic policy, putting their faith in central bankers,” he said.
“The consequences have been uneven and unrewarding, except for those with assets.”
However, Lyon warned that there was a risk of populist politicians “overpromising and underdelivering”, adding: “The paradox of some of Donald Trump’s policies is that they may exacerbate inequality rather than reduce it.”
He added: “Certainly the beneficiaries of income tax cuts are likely to be high earners with a low propensity to spend. Protectionism… is unlikely to improve the outlook for world growth.
“A contraction in global trade began a couple of years ago and today’s tendency to introduce further trade barriers will extend the well-established trend.”
Highlighting comparisons made by commentators between Trump and predecessor Ronald Reagan, Lyon said there were a number of flaws in comparing the two.
Source: Troy Asset Management
Unlike Trump, Reagan began his presidency with low debt-to-GDP ratio, with treasury yields at high levels and stock markets trading at lower multiples, Lyon notes.
Also unlike Trump, Reagan embraced free trade and market forces, he says. Trump, meanwhile, enters the White House with seven years into an economic upturn and eight years into a bull market in stocks.
“Contrary to the prevailing view the president of the United States is not omnipotent,” the fund manager said. “Whether he can hold back the powerful forces of deflation, be they from demographics, debt, technology or globalisation, remains to be seen.
“A resurgent US dollar, resulting from rising protectionism, will not help. For the moment, markets seem to be giving Trump the benefit of the doubt.”