TEAM plc (LON:TEAM) Head of Multi Asset Investments Craig Farley caught up with DirectorsTalk for an exclusive interview to discuss the resilience of headline equity indices, central banks’ battle with inflation and how his views are evolving as we move into Q3.
Q1: What has characterised performance in Q2 this year and how would you explain the resilience of headline equity indices during the period?
A1: Very much a risk on quarter that has likely surprised many investors against the backdrop of the fastest monetary tightening cycle in history.
Credit markets are behaving themselves very well and headline global equities still performing exceptionally. Bond markets, on the other hand, are a singing a very different tune with inversions across the curve screaming out recession and rate cuts.
Really, at the centre of this, a global recession led by the US that many had predicted for 2023 thus far hasn’t materialised and what we’ve seen is a very resilient US consumer, that in part has been driven by excess savings accumulated during COVID still being drawn down by households. Also, driven in part by the very significant correction we’ve seen in oil and gas prices and also commodity prices during the first half of this year.
That’s really percolated through to the economic data releases we’ve seen during the quarter and also fed through to risk assets in the marketplace via the positive impact that the consumer has had on company earnings.
So, this hyped up substantial profit decline, again that many were forecasting, hasn’t come through as yet, and corporate America in aggregate still seems to be in reasonable shape.
Turning to equities, specifically mega cap stocks have once again dominated the headlines during the quarter, this past three months, it’s been led by the frenzied excitement around generative AI technologies.
AI technologies run on computer processing power and data so investors have adopted really the ‘own picks and shovels during the gold rush’ approach by aligning themselves with themes that they think will most benefit from the potential productivity surge from AI. That’s created a very material differential in performance technology and consumer related stocks have been top of the pops and some of the more value orientated defensive sectors have materially underperformed.
That’s really been the story so far during the first half of this year.
Q2: Bond yields continue to move up as they price in further rate rises, it’s a bit of a mixed picture but it looks like central banks’ battle with inflation is far from over?
A2: Very much a mixed picture. We’ve got policymakers in different parts of the world grappling with different phases of this inflationary cycle and our view at TEAM at this juncture really is that the US, if you like, is leading the ugly contests in terms of being the central bank with the least amount of work to do in this cycle.
US CPI Print for June was 3% with all major sub-components trending lower for CPI ex. Food and energy, on an annualised basis now is running below the Fed’s stated 2% target. When we look at realtime economic indicators, they’re pointing to roughly growth of 1%, that’s below long-term trend and we think the lens of the market and the Feb will be shifting materially away from the inflation picture to the growth outlook in the months ahead.
Turning to Europe, the European Central Bank is combating competing concerns really, on the one hand, a strong slowdown in growth, on the other, still stubbornly sticky core inflation at over 5%. Rises wages there being fed by a tight labour market and money market futures there pointing to at least two more rate rises before the year is out.
Closer to home, in the UK, the Bank of England is in the proverbial straitjacket so incredibly now, it’s materially cheaper for the Bank of Greece to borrow over 10 years than it is for the Bank of England. That doesn’t necessarily reflect solvency concerns per se, it is the market’s view or current lack of confidence really in the Bank of England to slay the inflation dragon. So, we think there’s more work left to do there for the Bank of England.
Regardless of which economy we’re looking at, once the policy normalisation does take place, our own view is that it looks to be a move back to low single digit interest rates, rather than a return to ZIRP – zero interest rate policy – that ahs been the mainstay of the economies for the past decade or so.
Q3: Can you outline how your views are evolving as we move into Q3 and why your shift in risk appetite?
A3: So, we’ve entered the third quarter of this year more positively positioned from a risk perspective and we’ve materially increased equities throughout this year. We’ve seen a significant improvement in price trends across risk assets and market breadth has also been improved as some of the cyclical sectors including homebuilders, airlines, cruise liners and also industrial stocks have taken the baton really from technology in propelling this market higher. That to us is a healthy development.
If we turn to fund manager survey positioning and sentiment data, that also suggests to us that there is still a marginal buyer of risk assets at these levels as some of the concerns over the economy and the stock market dissipate in the months ahead.
Our own preference really for equity exposure at this juncture is US large cap global value, Japan, selective emerging markets including India where we’re very positive and also the UK where we appreciate the economic malaise.
When we look at long-term valuations at investor sentiment and positioning data, that all suggests to us really that pessimism over the prospects for the UK is at an extreme low level and it really doesn’t take much for the news to go from awful to slightly less awful to create that rubber band effect and actually produce a positive market surprise. That’s certainly the message we are getting from fund managers, at the coalface talking to companies, that the message really is that things aren’t quite as bad as they see.
Within fixed interest, our preference is for emerging markets, sovereign bonds on attractive valuations, attractive real interest rates and peak policy rates, and we also like investment-grade corporate bonds where aggregate yields are now the most attractive really, they’ve been since the depths of the global financial crisis.
Within our alternative sleeve, we’re actively looking for triggers to increase our commodity exposure. Part of that is going to be renewed dollar weakness as some of these interest rate gaps narrow. We’re also looking at agricultural and food commodities very closely as we’ve seen over the past few weeks several key growing regions are really suffering very hot and dry weather conditions and that’s likely to create an upward pressure on prices.
Finally, cash has reemerged as an asset class after many years in the wilderness, an example of that, 5.2% now in US T-Bills completely risk-free, clearly has raised the hurdle in terms of capital allocation to other areas of our menu.
I think the overall picture from TEAM is very much that flexibility in terms of approach and capital allocation is going to remain key as it has done in the post pandemic cycle, and as risks and opportunities present themselves in the coming months ahead.
