Refocusing on fundamentals in challenging markets
Insights

Refocusing on fundamentals in challenging markets

Refocusing on fundamentals in challenging markets

When you can’t list all the top concerns for markets on a single hand it’s easy to be pessimistic. We do not underestimate the risks, not least that of a future US recession, but we still see good value in equities as the economic recovery continues for now. However, in the face of these challenges, we are focussing our portfolio on companies that can deliver profits in the face of inflation, rising interest rates and supply chain disruptions.

Markets face a laundry list of structural and cyclical challenges

First, tightening liquidity and moderating economic growth present a challenge to equity markets. It will also drive volatility in the near-term as investors look for signs of a recession or ‘soft-landing’ in every data point.

Second, every cycle is different, but we do face a very real prospect of a secular change in the backdrop for financial markets. From the early 1980s inflation and interest rates began a long decline and this coincided with a significant re-rating in global equity markets, led by the US. A secular upturn in inflation and interest rates will have negative implications for the rating of equities.

Third, the global economy of the last few decades has not proven resilient to attempts to ‘normalise’ monetary policy and each tightening cycle has led to lower peaks in interest rates and lower lows on loosening. So high debt burdens could lead to a less aggressive tightening cycle than currently assumed.

Fourth, bond markets normally adjust expectations with respect to central bank policy relatively slowly. Instead, we have seen a historically rapid change in expectations. Equity markets have performed relatively well, despite this rise in discount rates, as they are a better hedge to inflation.

Fifth, while the Ukraine conflict has presented a terrible spectacle in terms of humanitarian costs the market has largely performed to type, with a kneejerk negative reaction and subsequent recovery. There are broader economic implications to the conflict, felt through higher inflation due to rising commodity prices and further disruption to supply chains, as well as structural changes, pushing de-globalisation and increased spending on defence.

Sixth, China continues to pursue a zero-Covid policy which appears both illogical and highly disruptive to their growth. The ongoing prospect of lockdowns presents significant risks to growth and risks further pressuring global inflation due to disruption to supply chains.

Seventh, rising food prices disproportionately hit the poorest, and present a threat to stability in emerging markets. We have already seen social unrest in South America and subsidisation of fuel prices will put government and consumer finances under severe pressure.

US recession is the top risk, but history suggests we are at least a year away from the peak in equity markets

While the top concern for investors is that current tightening cycle leads to a US recession, we do not think it is an imminent risk. History suggests that we are still too far away from this event for markets to price this in. Indeed, markets do tend to perform well for a good period after the yield curve inverts, and recession comes into view. On this basis, we are still at least a year away from the peak in equity markets. History, however, is only a guide and we have an unusual combination of already slowing growth, rising rates and moderating inflation which will likely worry investors and make markets volatile.

Cutting unnecessary risks and focusing on fundamentals in the portfolio

So, how have we responded to this laundry list of concerns in the portfolio? We have cut unnecessary risks and refocused the portfolio on the strong, core fundamentals of equity markets.

  • Reduction in gearing levels. We believe that it remains appropriate to hold a positive gearing position for the fund for the time being, given still deeply negative real-interest rates, but have already cut leverage.
  • Reduction in the sterling hedge. The outlook for the dollar is uncertain but sterling tends to decline in a ‘risk off’ event.
  • Reduction in small cap exposure. While small caps have underperformed and are trading at low valuations versus large caps, we view them as less well placed to withstand rising input costs and, consequently, profit margins are at risk.
  • Further sale of US large cap growth. We have switched to favour value stocks in the US as the valuation spread between these areas remains high and macro variables are not supportive.
5 May 2022
Paul Niven
Paul Niven
Head of Asset Allocation (EMEA) at Columbia Threadneedle Investments
Share article
Share on twitter
Share on linkedin
Share on email
Key topics
Related topics
Listen on stitcher badge
Share article
Share on twitter
Share on linkedin
Share on email
Key topics
Related topics

Risk Disclaimer

The value of an investment is dependent on the supply and demand for the shares of the Investment Trust rather than its underlying assets. The value of an investment will not be the same as the value of the Investment Trust’s underlying assets.

Views and opinions expressed by individual authors do not necessarily represent those of Columbia Threadneedle Investments.

Past performance is not a guide to future performance. Stock market and currency movements mean the value of investments and the income from them can go down as well as up and you may not get back the original amount invested.

Related Insights

8 August 2022

Steven Bell

Director, Multi Strategy Investments

When will central banks stop hiking interest rates?

Chief Economist, Steven Bell expects further rises but believes that the Federal Reserve needs to go much further than its UK and European counterparts.
Watch time - 5 min
5 August 2022

ESG knowledge shared: August 2022

Keep up to date with responsible investing in our monthly roundup of highlights – interesting events, articles we’re reading, podcasts and more.
Read time - 4 min
2 August 2022

Jim Griffin

Investment Content Manager

Market Monitor – 29 July 2022

Stock markets around the world have enjoyed a largely positive week despite another large interest-rate increase by the US Federal Reserve (Fed) and signs that the American economy may be in a recession.
Read time - 2 min

You may also like

Investment approach

Teamwork defines us and is fundamental to our investment approach, which is structured to facilitate the generation, assessment and implementation of good, strong investment ideas for our portfolios.

Funds and Prices

Columbia Threadneedle Investments has a comprehensive range of investment funds catering for a broad range of objectives.

Our Capabilities

We offer a broad range of actively managed investment strategies and solutions covering global, regional and domestic markets and asset classes.

Please confirm a few details about yourself to visit your preference centre

*Mandatory fields

Something went wrong, please try again

Thank you. You can now visit your preference centre to choose which insights you would like to receive by email.

To view and control which insights you receive from us by email, please visit your preference centre.

Looking for help?

Adviser Edge

Access professional support focusing on financial planning, investment and practice management. Create an account to access structured CPD content and log your CPD hours.