Investors should not be complacent about markets and remain open-minded to the possibility of a potential shift, according to Jupiter Asset Management’s James Clunie.
Markets continued to climb higher in 2017 despite a number of potential geopolitical headwinds and concerns over valuations to name but a few of the challenges.
Clunie, Jupiter’s head of strategy – absolute return, said one of the key questions heading into 2018 was how much longer the current market regime will continue.
He said: “Unfortunately, changes in market regime often require the benefit of hindsight to be confirmed – if we knew for certain, we’d be able to go ‘all in’.
“Nevertheless, the market has been giving off some interesting signals in recent months. At the very least it would be unwise to be complacent about what might happen next.”
Clunie, who manages the £1.3bn Jupiter Absolute Return fund, said markets have been “unusually stable” recently.
“A number of stock market indices have reached record highs and volatility of these indices has been unusually low throughout much of the past year,” he said.
As the below, chart shows the S&P 500 has climbed higher, while the VIX index – a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices – has remained low.
Performance of indices over 10yrs
Source: FE Analytics
However, he said there were signs that assets were acting in a way that was unusual compared with historic patterns of behaviour.
Indeed, the fund manager said turbulence levels within indices were high and that it was “sensible for investors to consider taking less risk”.
A further dynamic in the market to watch out for next year, said Clunie, is the valuation gap between growth and value stocks.
Value stocks outperformed the growth style in 2016 for the first time in several years, however, that trend has reversed in 2017.
The MSCI World Growth index has delivered a total return of 16.32 per cent this year compared with a 7.16 per cent gain for the MSCI World Value index, as the below chart shows.
Performance of indices
Source: FE Analytics
He said: “Growth stocks have been the key driver behind the market’s performance recently, while value stocks have fallen.
“We have seen nascent signs of a reversal of this pattern, which could be important because a stock market rotation out of growth into value is something that has been witnessed in the run-up to a number of financial downturns.”
The fund manager said such an example could be seen during the late stages of the dotcom bubble of the early 2000s when technology stocks were highly valued.
Other signs that risk may be building in markets, said Clunie, include the “speculative fervour surrounding Bitcoin”.
The digital currency has surpassed the $15,000 level with some still flocking to capture any further upside, which has been described by commentators as the ‘fear of missing out’.
Clunie said what has been unique to the late-cycle phase of markets is that rather than greed, the trend has been driven by need.
“For years, pension funds have been forced to find bond-like assets against which they can match long-term liabilities,” he explained.
“Similarly, ETFs and index funds have been forced buyers of assets regardless of price as investors have poured into those funds.”
Clunie added: “In my view, ‘need’ seems to be what’s driving a lot of behaviour. Unlike ‘greed’, which involves an investment choice, need always results in a transaction. For me, that is the real source of the fragility in the current market.”
The fund manager said that with central banks beginning to withdraw support after years of quantitative easing and low interest rates since the global financial crisis, fragilities could begin to return to the market.
“While we can’t predict a change in market regime, we believe it is important to be open-minded to the possibility that one might be due,” said Clunie.
“Betting against a late-cycle market is inherently painful due to the excesses that are often produced, with share prices potentially reflecting unreasonable expectations.”
As such, Clunie said his strategy was to “lean against” the prevailing tendency of markets by taking modest position sizes and “acting incrementally, rather than dramatically” to new information about stocks.
“We find that this can help us avoid under and overreacting to change and means that we continually recheck our original thinking about a position, carefully weighing up the value of new and old information,” he explained.
“We believe that a move towards greater risk awareness by other participants in markets would likely benefit our strategy.”
The Jupiter Absolute Return fund aims to generate an absolute return over a rolling three-year period, independent of market conditions and investing on a global basis in a range of assets.
Clunie took over the fund in 2013 and over three years it has returned 14.32 per cent.
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
The fund features on the FE Invest Approved List and is highly recommended by advisers featuring in all three Adviser Fund Index categories: Aggressive, Balanced and Cautious.
“The manager has used the same strategy since 2009, which he exported from Scottish Widows to Jupiter in 2013,” FE analysts noted.
“He perfectly understands its strengths but also its weaknesses, meaning that he can limit the risk in the portfolio if he believes the strategy can’t perform. It happened several times in the past and the capital loss has been small in those periods.
“We believe this fund is a useful tool to have in the box when investors expect a shift in the economic regime.”
The fund has an ongoing charges figure (OCF) of 0.86 per cent.