Investors should take action now if they are worried about the fragility of global economic growth, according to Rathbone Unit Trust Management’s James Thomson.
The FE Alpha Manager of the five FE Crown-rated Rathbone Global Opportunities fund said that equity investors concerned by an economic downturn should be moving away from those stocks most sensitive to any change in conditions.
For much of the past 18 months two main factors have caused concern for investors – valuations and politics – something that fellow FE Alpha Manager Nick Train spoke about on FE Trustnet on Thursday.
Like Train, Thomson believes that neither make much difference to his fund, as political noise often has a minimal impact on markets one year later.
Similarly, he noted that valuations are a poor predictor of future returns. Indeed, the chart on the left demonstrates why Thomson believes there is no link between valuations and returns at least over a one-year period.
Valuation and business cycle returns after 1yr
Source: Rathbones
However, where there is a very strong link, and where investors should spend most of their time thinking about, is between returns business/economic cycle, as shown on the right.
“Outside of Trump and the noisy geopolitics, this is what investors should focus on because this is a very strong predictor of stock market performance and frankly what I see is quite worrying,” he said.
Thomson said the amount of quantitative tightening in the pipeline from both an unwinding of quantitative easing and rising interest rates means that the economic growth could be quite fragile.
“Some of the leading indicators are pointing to a deterioration in growth and that we as a result of that should be more cautious and should tilt the portfolio away from the most cyclical, economically-sensitive parts of the market,” the fund manager said.
Sectors of which include commodity-related stocks and economically-sensitive industrials as well as interest rate sensitive banks and financials.
From a geographic perspective, investors probably want to avoid emerging markets because they tend to be the most economically-sensitive, he added, although Thomson noted that he does not invest in the region anyway.
As a result of this, Thomson has tilted the Rathbone Global Opportunities fund towards more stable, predictable and reliable businesses, including healthcare companies, care homes, a waste recycling business and a pest control business.
“I have always had a portion of this fund dedicated towards these ‘weather-proof’ companies that are less economically-sensitive but I have pushed that up to higher levels than it ever has been with 25 per cent-plus of the portfolio in these businesses,” the fund manager said.
Conversely, he is avoiding value stocks, which he said offer a “mirage of safety” but are among the most likely affected by a market downturn.
“It is an illusion, I think, that this low valuation provides safety as in actuality the underlying businesses of these companies are very economically-sensitive,” said the Rathbones manager.
“So, if you kick out one of the legs of the stool, which is economic growth, then you are going to see the impact on the profit & loss of these companies and it is not going to be pretty. They will be hit hardest I think in any kind of economic deterioration.”
This, he said, is part of the reason global value stocks have underperformed their growth counterparts over the past decade, as the below chart shows.
Performance of indices over 10yrs
Source: FE Analytics
Indeed, while the economic recovery has been among the longest in history, it has also been particularly shallow, as economic growth has failed to really pick up.
At times of low economic expansion, growth stocks tend to outperform, while when the global economy is more robust value stocks tend to be the better option.
“If you believe that economic growth is going to be very robust and GDP growth is going to be consistently above-trend then actually avoid me and my fund,” the manager of the £1.2bn Rathbone Global Opportunities fund said.
“You can happily own value stocks in that scenario because they will be the greatest beneficiaries in that and not me.”
Thomson added: “It does feel more fragile and that the risk is to the downside. We have had a very long period of recovery now from the financial crisis.”
In recent weeks, other industry commentators have also noted that the environment feels more fragile, with Schroders’ Michael Scott and Capital Economics’ Simona Gambarini.
However, rather than avoiding the region, Thomson said, although it may be seen as counterintuitive, investors should be looking to take on US exposure.
“If you believe in a synchronised global slowdown and you want to be cute on your timing then you shouldn’t be in any markets. But for the most part people want to be invested, have a long-term view and so I still think that the powerhouse of global economic growth is the US,” he said.
“The US still provides a market which has the least volatile economic growth in the world and so even if you have a slowdown which starts in the US and the cold spreads worldwide it is still probably the best place to be if everybody is sick.”
As such, the Rathbone Global Opportunities fund is overweight the region currently, with 58.57 per cent invested in the US.
Geographical split of fund
Source: Rathbones
“I think the US is still a safe haven in a pretty sickly global economy and the amplitude of the deterioration will be shallower in the US,” Thomson said.
The manager has run the portfolio since 2003, with deputy Sammy Dow joining him in 2014. It has been a consistent performer over the last decade, sitting in the top quartile of the IA Global sector over one, three, five and 10 years. It has a clean ongoing charges figure of 0.79 per cent.