It has been a “gruelling” first half of the year for investors and things may get worse before they get better, according to Janus Henderson’s head of multi-asset Paul O’Connor, who said that equities are still not cheap despite falling off a cliff in 2022.
So far this year, investors have found few places to hide, with Trustnet data revealing that just seven Investment Association sectors have posted a positive return year-to-date. There have been some extreme losses among certain areas of the market, while the gainers have been underwhelming overall.
Even when trying to paint a positive picture, O’Connor admitted it was difficult. There are not many optimists left, with most measures of market sentiment plunging, but he noted that in the past, this has been a buying signal.
At these levels, there is usually “contrarian support for a tactical rebound in risk assets,” he added, although while there is the potential for tactical, short-term gains, those with a longer-term view are unlikely to make money from such a strategy.
“Further encouragement can be drawn from the observation that the first half of July has been the best half-month of the year for stock returns since 1930,” he added, although admitted he was still “wary of expecting too much from relief rallies”.
In reality, investors should anticipate a “stormy” few months ahead for risk assets such as equities, which are likely to face significant headwinds from central bank policy, geopolitical issues, and economic growth concerns.
The latter of these threats is the most important from an investment perspective, as monetary tightening from central banks has led to flattening yield curves, widening credit spreads and reduced inflation expectations.
O’Connor agreed with Premier Miton’s David Jane, who earlier this week argued that a recession was on its way. The head of multi-asset at Janus Henderson said investors will recognise that most central bank tightening cycles have ended in recession, while most rate cycles start with an overheating economy – not a benign one.
“Since 1955, the US economy has always experienced a recession within two years from every quarter in which inflation was above 4% and unemployment was below 5%, as they are today,” he noted.
Consumer confidence also hints at worse to come, with readings lower than in the six previous recessions since 1980. The bottom will likely arrive in the second half of the year, with two potential paths: the first is bumpy, involving equities and credit selling off amid the “worst plausible economic scenarios”.
A more benign route would involve inflation cooling unexpectedly, with the rate-hiking cycle brought to a swift end. “Both still seem some way off,” said O’Connor.
However, while markets are now pricing in a slowdown, they are still a long way from pricing in a recession.
“Economists have already begun to slash growth numbers, but equity analysts do not seem to have got the memo yet. Consensus expectations for global earnings growth of 11% for this year and 8% for next look highly optimistic,” O’Connor said.
While stocks have sold off in recent months, they do not look cheap, as they have re-rated “no more than they should have” given the risks in the market.
As such, the head of multi-asset is underweight equities in his portfolios, but has remained overweight large-cap UK stocks, noting that the FTSE 100 index is one of the few that is “attractively valued”.
He pointed to the index’s relative overweight to cyclical assets, including oil, mining and financials, which are “well suited to the prevailing late-cycle macro environment”.
The other area that he is allocating to is China, where the firm moved to an overweight position in the second quarter of this year.
“Chinese equities have already experienced a major bear market, a significant valuation de-rating and wholesale investor capitulation,” he said, yet it is one of the few markets in which monetary, fiscal, and regulatory policies are “all tailwinds”.