An arguably long overdue slump in US tech stocks is being hailed as a ‘great rotation’ from growth and momentum to value. While we take care not to be crystal ball gazers, we may be seeing a significant change in market dynamics.
We have been here many times before. Since the Global Financial Crisis, there have been a number of false dawns for value, most recently in the fourth quarter of 2020 after the announcement of Covid vaccines. But now we are seeing signs there are potentially seismic shifts in the investment landscape.
With valuations high for the main indices, central banks showing resolve in combatting inflation, year-on-year growth comparatives set to disappoint after last year’s strong rebound, and geopolitics presenting increasing risk, investors have started the year on a nervous footing, quick to liquidate their positions.
First on their list of sell orders, US technology stocks represented by the Nasdaq Composite index almost entered a bear market this week (a drop of more than 20%) from their high on 22nd November.
Fed removes market backstop
So, what is driving the sea-change in investor sentiment? Undoubtedly, central banks and, chiefly, the Federal Reserve, are central to the current dynamic.
In this week’s Federal Reserve announcement, the US’s central bank signalled rate hikes and a path to monetary normalisation, but also effectively took away the market backstop – further quantitative easing and rate cuts.
This combination significantly darkens the outlook for growth stocks and fixed income securities. This is because, historically, the higher the interest rate, the higher the discount rate used in valuation models, and the lower the value of future growth when brought back to today. While higher rates have the effect of eroding the income from bonds paying a fixed coupon.
Conversely, with less emphasis and worth assigned to future growth, value companies look increasingly attractive, particularly when their business models are sound and their valuations remain at historically low levels both in absolute and relative terms.
Investors, having joined the fast-paced technology train late and suffered heavy losses, might be prompt to jump ship to protect their eroding capital, while earlier passengers might naturally want to recycle their gains into the next big thing. This could be the beginning of a great rotation indeed.
Thriving in an inflationary environment
While we are not in the business of predicting the future, we ensure our multi-asset portfolios can navigate a range of economic and market scenarios. And if we look at our current asset allocation, we've got a lot of exposure to equity value strategies, which are particularly well-positioned in an inflationary environment.
Our fixed income allocations are currently relatively low given the low yields on offer and the risk of higher, persistent inflation. However, we do hold the TwentyFour Income fund where the underlying asset-backed security holdings are floating rate in nature and thus their coupons move in tandem with rising rates. We also own the GCP Infrastructure Trust which gives us exposure to infrastructure debt, which is an area offering attractive growth and built-in inflation linkage.
As value-orientated investors we have been looking at volatile markets to add some risk. Those opportunities came up in some of the recent underperforming areas, for example in Japan (AVI Japan Opportunity Trust) and Emerging Markets (Fidelity Asian Values, Fidelity China Special Situations, BlackRock Frontiers).
At a more trust specific level, we also added to our positions in the Blackrock World Mining Trust and the Ecofin Global Utilities and Infrastructure Trust, whose abnormally wide discounts in December didn’t tally with our positive views of the managers, their portfolios, and the overall macroenvironment.
We like having exposure to commodities, which is traditionally a good inflation hedge, and combine our broad mining exposure above with a specific gold and silver fund (Jupiter Gold & Silver). Not only do precious metals usually perform well in an inflationary and volatile environment, but mining companies offer strong balance sheets, high cash flow generation and trade particularly cheap relative to the rest of the market.