Whether it's bold euphoria around artificial intelligence or more cautious investment in government bonds, there's plenty of action in the investment market to keep things interesting.
SoGlos chats to Cheltenham-based RBC Brewin Dolphin about the range of possibilities on the most attractive returns in a lively 2023 so far...
About the expert — Tom Barton investment manager at RBC Brewin Dolphin
Tom Barton has thoroughly enjoyed his eight years so far at RBC Brewin Dolphin and finds it motivating to work with members of the team who've worked there for more than 30 years.
He loves the long-term thinking of the team and focusing on clients’s needs. He also values working for a national firm, with more than 30 offices across the UK, Channel Islands and Republic of Ireland, but, importantly, with a strong local presence in Cheltenham.
Can you give us a brief overview of what has happened in the markets so far in 2023?
Markets started the year pretty strongly on renewed optimism around peak inflation and a general sense of ‘it’s not so bad’ following the annus horribilis that was 2022. Then came the US regional banking crisis and the collapse of Silicon Valley Bank (SVB) which prompted a sudden and sharp reversal in these early gains.
These banking failures were ultimately the result of poor management controls and regulatory oversight but, nevertheless, they raised fears of a broader contagion and led to large deposit outflows at Credit Suisse, culminating in its forced purchase by UBS.
Relative calm returned to financial markets quite quickly, however, as it became clear that these failures were outliers among other banks and not symptomatic of broader weakness in the banking sector. Our view throughout has been that the banking system is sound and that we were not about to witness a repeat of the 2008 financial crisis.
Both bonds and equities generally moved higher during the second quarter of the year, which confounded macroeconomic forecasters and investors alike, with persistent inflation and higher interest rates coinciding with generally solid economic activity and market performance.
Part of the reason for this strong market performance is that corporate profitability has generally been robust. Also, the scariest headlines this year have been the things that investors were already braced for. Whilst these headlines haven’t been great, principally regarding high inflation and rising interest rates, they haven’t perhaps been as bad as investors felt they could have been.
Beyond this, the US tech rally redux has continued. Probably in no small part due to a combination of investor under-positioning, the liquidity injection following the collapse of SVB, and excitement around generative artificial intelligence (AI). Early signs of AI’s potential and a generous serving of FOMO have helped drive narrow leadership in the US market’s performance, with just a handful of big tech companies driving a large proportion of the US market’s overall return so far this year.
How has the FTSE 100 performed?
The UK’s FTSE 100 index is often looked at closely in the UK press. Its links to the UK economy are, however, somewhat abstract, with it effectively being an index upon which a number of globally operating companies list their shares.
The UK market was one of the better performers last year, aided by some largely unfashionable companies, particularly those operating in fossil fuels and mining industries, having a great run in 2022. For large parts of this year, however, the UK has been out of favour, with many investors having sold UK assets to channel money overseas, where investment prospects are seen to be more exciting. The result of this negative sentiment towards the UK, however, is that many UK-listed stocks are valued at a discount to their overseas-listed peers.
The more UK domestically focused FTSE 250 index has also struggled to push on in 2023. Inflation is the key theme here, with many other developed countries seemingly being more successful in bringing inflation under control.
Tell us about an area to have performed well so far this year?
The relatively muted performance of the UK equity market so far this year contrasts with strong returns elsewhere. Paradoxically, the shares which are usually most vulnerable to rising long-term interest rate expectations, technology shares, have exhibited some of the strongest performance so far this year.
In terms of what’s driven the tech resurgence, this primarily reflects the current euphoria around AI and the potentially massive profits to be had for the industry ‘winners’ in this space. A resilient Q1 earnings season and the taming of US inflation (which implies we’re likely closer to peak US interest rates) have also helped.
Something we are cautious of, however, is the fact that the US market’s strong performance has been driven by a very small number of tech behemoths, such as Amazon, Microsoft, Nvidia and Apple. Such a narrow market has prompted us to question whether some of the risers can justify such inflated valuations. Generally speaking, a lack of breadth (i.e. where returns are driven by a select few) is bad – market trends are seen as stronger when the gains are spread more evenly across the constituents.
That said, it comes down to your view on AI and the extent to which this could truly change our working lives. We may well be on the verge of the next technological revolution, which might make a bet against US tech a bold one.
Which areas are you currently looking at for the risk averse?
Bonds, government bonds in particular, are likely to have a role to play for risk-averse investors. Following last year’s falls, we have seen an increase in the returns available from this asset class.
Bonds provide an income stream (more this year than in the years before), but also some resilience if the market anticipates interest rate cuts on the horizon. US investors think that US rates will come down quite quickly. It looks probable that UK rates will come down more patiently. We have therefore taken the view that there are better returns to be made from UK bonds, which are poised to benefit should expectations about UK interest rates come down in the future.
Rising bond yields have been painful but they offer the promise of a brighter future. Bonds are now offering attractive returns and, in some instances, remarkable tax efficiency which make them worthy of serious consideration for certain clients.
For bold investors, where are you currently looking?
Where appropriate, I have been looking to boost exposure towards emerging market equities. Investing here has rarely been without risk, and political and economic challenges have not disappeared, but the big picture investment case has not changed much over the past decades: demographics, faster growth, lower valuations, the rise of the middle class and under-researched companies.
And yet, as an asset class, emerging markets haven’t been doing a lot of emerging lately, with returns well behind those of developed market equities in what has been a largely unremarkable 10 years.
Rising interest rates around the world have reduced the appeal of risky assets, which has made emerging market stocks particularly exposed. Political risk is also a clear factor on investors’ minds. The war in Ukraine has undoubtedly changed the way global investors consider asset allocation, increasing dramatically the country risk premium for the likes of Taiwan and China.
One could argue, however, that this weakness has resulted in a decent entry point, with emerging market valuations at multi-year lows relative to developed markets, generally lower inflation, lower debt levels, and higher growth rates. Often, short-term underperformance creates an attractive buying opportunity for long-term investors.
Emerging market economies offer strong domestically driven growth as well, with a growing share of world exports backed by economies of scale and a large, relatively young, talent pool. In addition, emerging markets are likely to benefit from several secular tailwinds versus developed markets, including increased infrastructure spending and rapid digitalisation.
Disclaimers
The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. The information in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Opinions expressed in this publication are not necessarily the views held throughout RBC Brewin Dolphin Ltd. Forecasts are not a reliable indicator of future performance.
