TEAM plc (LON:TEAM) Head of Multi Asset Investments Craig Farley caught up with DirectorsTalk to discuss key market catalysts to market performance, a shift in the financial market landscape, asset allocation for 2023 and provides a summary of the year ahead.
Q1: 2023 presents a number of market catalysts as well as risks but what do you view as key to market performance this year?
A1: In the short term, I think there’s three interlinked themes that are likely to determine the path for our set prices this year:
A Fed pause or pivot – markets are effectively now pricing in a scenario that’s sees interest rate cuts in the coming quarters, that’s the complete opposite to the timing cycle we endured through 2022. A softer economic data, including the consumer confidence surveys, they’re all at levels consistent with a pause or a pivot but the issue is that the hard inflation data; that’s the data that the Fed is watching is not there yet. This week’s economic data in the US was a case in point; Q4 2022 GDP came in at 2.9% which was better than expected, the payrolls data, the employment data, came in better than expected so the consumers holding up okay and that created a headache for the Fed and potentially for the markets going forward.
The second issue is the potential for a US recession and the depth of that US recession, and the bond market is currently saying that is a done deal. The US government bond yield curve has already inverted sharply now for a period of time, that suggests the market is becoming increasingly concerned about near-term economic prospects. The 10-year 3 month yield curve inversion has a perfect 50-year track record, it has predicted eight out of eight recessions over that time period so we need to pay careful attention to that.
Finally, we’re knee-deep into corporate earnings season so that includes Q4 2022 results and also the full year results for last year. The top line earnings and sales figures are important but it’s the margins that the investors are going to be paying very close attention to with rising input costs and input costs pressures, are companies able to pass on those costs to the end consumers? So, we’re likely to see an aggregate downside pressure on margins and that’s going to have a very material impact on prospects for companies this year.
Q2: You have talked about a watershed moment in investing or a tectonic plate shift, what do you mean by that?
A2: Simply put, we think that the financial market landscape, that has been so kind to investors over the last 30 years or so, is materially shifting.
What we means is that globalisation, open trade, just-in-time supply chains, dependence on one supplier, the rise of China, China’s entry into the WTO in 2001 and this enormous young working population from Asia combined with major advances in technology and the energy space, that all created huge disinflationary forces for investors. That’s been a great environment for bonds and even better for equities.
Our view here at TEAM is that it’s very plausible that the COVID pandemic and the government response to it has bookended that unique chapter of financial history. The winds are shifting and we’re seeing moves towards balkanisation or fragmentation of industries and economies, autocracy we’re seeing the sourcing and hoarding of commodities as countries and economies look to secure energy supplies going forward. We’re seeing the duplication of supply chains and also military spending looks set to rise as governments reassess their defence budgets given the events over the last couple of years.
Now, a consequence of all of that is likely to be a more unstable, volatile world with inflation moving up to a higher plateau . That could translate in our minds to a more difficult environment for equities and certainly the need for investors to be able to access alternative revenue streams, particularly within the alternatives and the real asset space.
Q3: Could you talk to us a little about your view on asset allocation for 2023?
A3: TEAM has entered this year with much the same message, consistency of messages we held through 2022. We continue to advocate relatively conservative posture with regards to equity risk, and we’re very much focussed on selectivity this year.
This, in our minds eye, is not a buy all market so within our equity sleeve, we have a buyable approach but the core of that is very much back to basics. We’re seeking out companies that have very strong balance sheets, superior pricing power in their sectors, to be able to withstand some of the margin pressure that we’ve been talking about, and that generate consistent and dependable cash flow. Many of these companies will be found in the less sexy sectors, if you like, such as consumer staples or healthcare.
In a regional context, we like emerging market equities, we think that the weakening US dollar, China’s move towards a full reopening and also, most importantly, a widening gap in the earnings expectations and growth outlooks for emerging market relative to developed markets, provides some decent tailwinds for the emerging market economies. We think emerging markets should do reasonably well even in a bumpy year. We’ve also got healthy exposure to Japan and UK that offer historically attractive valuations and also a decent dividend yield than those markets.
Moving across to fixed interest, TARA there are reasonable alternatives that’s finally replaced TINA, there’s no alterative to equities in 2022. So, our preference there is to own good quality investment grade credits, selective emerging market sovereign debt and cash which has now returned as a viable strategic asset allocation after many years in the wilderness.
So, that blend of assets, we see generating between 4%-6% on an annualised basis for investors with very low levels of risk being assumed so that’s a pretty attractive outcome.
In the alternative space, finally, macro is definitely back so we like absolute returns strategies that can deliver uncorrelated return streams to everything else in our portfolio and absolute return funds can also deliver an equity-type hedge during periods of dislocation and stress in markets. Gold, gold miners and commodities remain stay in TEAM portfolio through 2022 and we’re positioned for a repeat this year.
Q4: How would you summarise the year ahead?
A4: We think, given everything that we’ve discussed here, it’s certainly not going to be a straight line from A to B, we do expect the road to be reasonably bumpy.
Risks assets have come out of the blocks pretty strongly this year so far. If we take quick step back and look at the starting point really, we can see why so valuations in the US started this year 30% or so cheaper than this time in 2022, investor sentiment coming into 2023 was pretty awful so from a contrarian perspective, the news only had to go slightly less bad to provide a shift in risk sentiment.
On the macro side, we’ve focussed here on the US but there are potential growth surprises, not just for the US but also from Europe, which has emerged from the harsh winter months in much better shape. It’s side stepped a lot of the energy blackouts and the supply security issues that many were forecasting only a quarter or so ago.
China has also got the potential to produce a significant growth surprise this year. one of the things we need to watch closely is that the middle class comes back and steps in to buy residential property after the trials and tribulations of the last 18 months. We’ll get a clearer view of that as the quarters progress towards the summer months.
From a technical aspect, the breadth of the rally since mid-October has been very impressive, we’re in a seasonally lucrative period in terms of the presidential cycle and the January effect.
So, that is all creating some short term optimism which we sympathise with. I think stepping away and looking out a little bit further than that, geopolitical risks loom large, we can expect more reverberations around Russia/Ukraine and in the Taiwan Straits as well. Also the lagged effects from all the monetary policy tightening we saw through the last 12 months and the bursting of the global housing bubble will start to bite through a little bit harder in the second half of this year and that’s likely to provide some headwinds.
So, in summary, I think it’s going to be a fascinating year for markets and investors. We think the ability to access a diverse asset allocation menu to be able to pull difference levers in terms of revenue streams through the year is going to be key as it the flexibility to allocate tactically and take advantage of short term opportunities.