Investors will need to learn to “buy the dips and sell the peaks”, according to Paul O’Connor (pictured), head of Janus Henderson’s UK-based multi-asset team, who says the market environment of the coming years will be characterised by higher volatility and lower returns
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The fund manager – who oversees the firm’s multi-manager range – said that 2018 was always going to be a year of transition away from a QE-driven bull run into a market that is more uncertain. And, while there have been many different narratives around 2018, for him the dominant theme has been a re-pricing of risk.
“In many ways investors came into the year complacent,” he said. “Investors came into the year extrapolating the benign conditions of 2017 and I think they have spent the year repricing risk on all different fronts.
“They were too complacent with growth, too complacent on the risk from central banks and too complacent on the risk from Donald Trump on the trade front.”
However, just as investors were wrong to extrapolate the benign conditions of 2017 into this year, O’Connor said they would be wrong to extrapolate the losses of 2018 into 2019. He added that while investors appeared complacent at the start of the year, the spike in volatility appears to have triggered an overly pessimistic view of the three major threats above.
“And it’s plausible that a couple of the really big risks, the ones surrounding the Fed and the ones surrounding trade, are getting close to peak,” he continued. “We could be at the point of maximum concern within a few months.
“As I look into next year, I think 2019 will share a lot of the characteristics of 2018: we have to expect returns to be low, we have to expect volatility, we have to expect variability of returns as well as the QE effect recedes.
“I think it is a year in which financial markets remain haunted by political risk and policy risk, as has been the story this year, but I still think it is quite reasonable to expect higher returns because we have priced in a lot of these fears.”
Despite many warnings that investors should prepare for a recession in the next 18 months, O’Connor is relatively unconcerned by this threat. He pointed out that most of the normal triggers for a recession appear absent and if the outlook for defaults and earnings proves correct, it suggests we are in the midst of a transition into a later stage of “an unusually elongated economic cycle”.
He is not the only one who thinks the market is being overly pessimistic. In a recent article on FE Trustnet, Merian Global Investors' chief executive Richard Buxton said it was “inconceivable” that the US would enter a recession within the next 18 months, while George Boyd-Bowman, manager of the Neptune US Income fund, said it was unlikely before 2021.
However, while O’Connor does not think next year will see a repeat of the losses across the majority of asset classes in 2018, he believes the volatility is here to stay. To show how unusual 2018’s benign conditions were, the manager pointed to the chart below showing the S&P 500 moved by more than 1 per cent in a single day on just eight occasions last year – over the past 20 years, the next lowest was in 1995, when it reached this milestone 15 times.
The manager said that in order to effectively navigate this new environment, fund managers will need to take more of a hands-on approach.
“In the same way that the QE era was a really great era for buy-and-hold and you didn’t really need much active asset allocation through this period, I think that we are moving into a world where asset allocation is going to be really important, both for reducing risk and for enhancing returns,” he continued.
“I think this choppy, volatile environment is one where we are going to need to learn to not only buy the dips, but also to sell the rallies. But this type of volatility does create opportunities as well.”
Turning to regional allocation, O’Connor said he has begun to take some money out of the US and recycle it into other areas that have fallen this year. However, he noted that while the trade wars may be nearing a resolution, the reason behind the fall in emerging markets may be more deep-rooted.
“I think when we look at the previous charts on China, most moves in markets we have seen this year are quite linked to macro fundamentals,” the manager said.
“Taking consensus GDP forecasts for major economies in emerging markets, what you can see this year is the weakening of macro momentum which is being shadowed by what is happening in currency markets.
“So we do need to see a stabilisation in macro momentum, we do need to see trade escalations peak, and we probably need to see a stabilisation in Chinese momentum before we start to call a bottom in emerging markets.”
One out-of-favour area O’Connor is buying across his portfolios – which includes the £367.2m Janus Henderson Multi-Manager Managed fund – is UK large caps, a process he started after the fall in Q1 and continued after the second major dip of the year.
The manager explained that the FTSE 100 has a high concentration of names that tend to do well at this stage of the economic cycle, adding that the fall in sentiment towards the UK has led to a large number of quality stocks paying very high yields.
However, he said this does not necessarily mean he is confident about a resolution to the UK’s Brexit-related issues.
“I would say that in aggregate, we take comfort from buying the FTSE because you are not really buying the UK economy, you’re buying UK assets that have got caught up in this,” he explained.
“I think if we were to focus on mid or small cap stocks or property, then we would need a lot more confidence in the UK and we would need a lot more confidence that Brexit was going to be resolved in a constructive way.
“That is a bet we are just not prepared to take at this stage.”