Are we at the end of an era? For many years now we have lived in an environment of ultra-low interest rates and quantitative easing. However, over the past few weeks, we have also seen the start of a big rotation in markets.
This seems to have been triggered by Donald Trump’s election as US president and an expectation that his policies will stimulate economic growth and interest rates will start to rise.
John Bennett, manager of the Henderson European Focus trust (HEFT), highlighted this in his recent manager’s report. He says that the period (almost a decade he thinks) in which investors have favoured quality growth stocks may be coming to an end.
He has been buying European banks recently in anticipation of rising interest rates, which can improve profitability for these companies because they can lend money to customers at a higher rate. The nervousness created by prime minister Matteo Renzi’s defeat and resignation in Italy and the effect this is having on the recapitalisation of struggling Italian banks makes that look like a bold move.
Deutsche Bank’s woes are also well documented. However, it is possible that this latest crisis for the European banking sector could mark the bottom of the cycle for them. If Bennett is right, Henderson European Focus will be well rewarded.
Sticking with banks, Mark Whitehead, manager of Securities Trust of Scotland (STS) thinks the Federal Reserve may be strong-armed, on the back of Trump’s policies, into raising rates. He is looking at increasing that fund’s exposure to US banks on weakness, focusing on well capitalised regional banks, to take advantage of this.
Comparing the one-month net asset value (NAV) performance of Global Equity Income funds and Global funds, the evidence of market rotation is patchy but is there to see. Scottish Mortgage (SMT), which is arguably the most growth focused global fund, has lost money since the US election.
The winners have been trusts such as Majedie Investments (MAJE), F&C Global Smaller Companies (FCS) and JPMorgan Global Growth & Income (JPGI), which are underweight consumer staples. The worst performer has been Murray International (MYI) (down 4.9%) which is heavily weighted to that area. It is a big reversal of fortune for that fund, which had a good run of performance over the previous 12 months after an extended period of underperformance of its peer group.
Bruce Stout, manager of Murray International, has been very worried about the increasingly desperate attempts by governments and central bankers to stimulate growth. His portfolio is focused on high quality companies with defensive earnings such as British American Tobacco (BATS) and Philip Morris (PM). These are exactly the sort of stocks that were hit after the election and tend to be left behind in a cyclical rally.
Brexit question mark
In the UK, the market is still heavily influenced by whatever version of Brexit looks most likely at any given time. Setting aside the big winners from the relief rally in the pharmaceuticals sector (which distorts the cyclical versus defensive picture), the largest rises in net asset values (NAVs) since the election have been delivered by smaller companies funds such as Chelverton Small Companies Dividend (SDV), Right and Issues (RIII) and Aberforth Smaller Companies (ASL).
Within the UK All Companies and UK equity income sectors, the winners have been Fidelity Special Values (FSV), JP Morgan Mid Cap (JMF), Lowland (LWI) and Standard Life Equity Income (SLET). By contrast, Finsbury Growth & Income (FGT), Troy Income & Growth (TGIT) and Perpetual Income & Growth (PLI) have fallen in value.
Fidelity Special Values’ Citywire AA-rated manager Alex Wright has been picking up cyclical companies for his portfolio for some time, taking advantage of their unloved status.
The market rotation into cyclicals has therefore been very beneficial for the fund. By contrast, Nick Train’s focused portfolio of companies with strong market positions was bid up to the point where the fund was a regular winner of awards and the beneficiary of substantial cash inflows. He has acknowledged that the fund’s good run of performance could not last forever and, this month, markets moved against him.
So, should we all be jumping on the new bandwagon? The share prices of these funds suggest investors are already, to some extent. Fidelity Special Values shares are up 11.6% over the past month against a 4.7% increase in its NAV. For Securities Trust of Scotland the equivalent figures are +4.9% and +2.3%. Investors are being patient with Murray International however, and its shares are up over the past month.
I can see how seductive the idea of resurgent growth driven by Trump’s policies might be and I can also see how dangerous to relative performance it might be to ignore this, at least in the short term. Not everybody is convinced we are entering a new golden era for cyclicals however. I think the most likely scenario is one of considerable market volatility for now. Agile stock pickers should be able to take advantage of this situation.
James Carthew is a director of Marten & Co