Managing uncertainty: CLAM fund managers consider the main issues for the year ahead
David Marchant, Chief Investment Officer, Canada Life Limited & Managing Director, Canada Life Asset Management Limited
As we reflect on 2023, with interest rates rising to their highest levels for many years (in the case of the UK, since the financial crisis of 2008), inflation remaining stubbornly high, wars in the Middle East and Ukraine and economic growth anaemic, it is perhaps surprising that equity markets have, in general, had a strong year with many stock markets delivering a double-digit return.
Yet putting a positive lens on events, inflation has fallen substantially, real wage growth is now in positive territory, interest rates have probably peaked and hopes of cuts in rates are building, despite what the Bank of England (BoE) is saying. For economic growth, the UK appears to have avoided a widely expected recession and while backward looking indicators show that growth is doing no more than bumping along at close to 0%, sentiment indicators are improving both for the corporate and consumer sectors, giving us confidence for next year.
Markets react to what is expected to happen, not what has happened, and with the outlook improving for both bonds and equities there are reasons to be more cheerful as we enter 2024. However, our usual advice – take a long-term view, don’t get distracted by market ‘noise’, diversify – remains as appropriate as ever, particularly given the uncertainties that prevail. I expect 2024 to be another ‘interesting’ year.
Bimal Patel, Senior Fund Manager, Global Equities
Our view as we enter 2024 is that economic data in the US is stronger than most expected but is slowing, with the inevitable impact of the interest rate hiking cycle still to come. Nonetheless, the labour market remains very strong. We believe that we are at or near terminal interest rates. However, the market is pricing in 125bps of rate cuts in the US in 2024, which we view as aggressive.
We consider that US companies are well positioned for this environment; the US continues to attract global listings, and there is an increasing trend of UK companies leaving the UK for the US. US productivity – and innovation (most recently, AI) – also remain well ahead of the rest of the world. AI has been a tailwind for the US market, although we believe that it is extending the growth rate for the US that would otherwise have declined naturally.
As we enter 2024, we remain focused on finding valuation dislocations. The lagged impact of interest rate hikes will likely give a whole range of interesting valuation entry points over the next few quarters.
We are focusing on consumer staples, where we are overweight, while maintaining an underweight in technology. Meanwhile, we are avoiding more cyclical sectors such as ‘bricks and mortar’ real estate, and parts of the consumer discretionary space. We do not hold regional banks, owing to creditworthiness and capital adequacy concerns.
Jordan Sriharan, Fund Manager, Multi-Asset
Our base case as we enter 2024 is for a hard landing for markets, but crucially, we do not believe that this will impact all asset classes equally. Since Covid, the economic picture has become more nuanced, putting a pause on the idea that all risk assets rise and fall equally. Instead, what we are seeing is a divergence in cycles across different asset classes.
At the moment, different regions are at different points in the economic cycle. Although the US stock market – particularly the Magnificent Seven-led NASDAQ – remains resilient, economic wins have recently been cooling. And while inflation in Europe has come down significantly, economic growth is weaker and expected to deteriorate. For China, policy decisions have already resulted in a significant contraction, especially in real estate and inward foreign direct investment.
Equally, the rules of engagement for specific asset classes have to an extent been rewritten – for example, there has always been a broad assumption that banks benefit from a higher interest-rate environment. Despite this the banking sector has had a difficult year.
In our view, a soft landing is unlikely. Since 1955, only once – in 1994 – has the Fed raised rates and not triggered a recession. We also believe that UK consumer spending in 2024 could slow. The evidence suggests that – rather than a structural shift lower in labour supply, as some commentators believe – the labour market is slowing, with wage growth reducing and job creation concentrated on COVID-hit sectors of leisure and tourism. In addition, the effect of higher residential mortgage rates is still being felt.
Given this backdrop, and now that we are in a world where the return profile of fixed income is considerably stronger than in recent years, we believe that defensive positioning, combined with shorter-term opportunities, is the best way to try to protect the portfolios, as well as generating returns.
We favour short duration credit (both investment grade and high yield) as we believe that this will help insulate the portfolios against idiosyncratic market movements, and don't think that the default rate will move materially higher. We also like more interest rate-sensitive equity sectors, e.g. in property where REIT valuations have stabilised, and believe utilities could offer protection in a hard landing environment.
Steve Matthews, Fund Manager, Liquidity
From our perspective, the main challenges for 2024 are likely to focus on regulation, liquidity and credit quality.
It is possible that the FCA’s drive for greater amounts of daily and weekly maturing assets in money market funds through its Money Market Fund (MMF) reform consultation paper will diminish returns for these funds. In turn this could potentially create opportunities for short-term or short duration bond funds, particularly in an environment where we are seeing rate cuts priced in.
In terms of liquidity, the crises of 2020, 2022 and 2023 have been important for the MMF sector, which has in general moved towards greater liquidity, placing it in a good position for 2024.
While the above crises were liquidity-based rather than being brought about by poor credit quality, the continued pressure on personal and business budgets from elevated borrowing rates must surely impact economies soon. Any downturn in GDP could materialise in the form of bad loans at banks and profit warnings across the spectrum, potentially impacting credit ratings. This means that we need to remain vigilant of the data and focus investing in issuer banks that are ‘national champions’.
Core inflation is also likely to be a factor. Recent data shows that hiring and permanent job postings are dropping and wage growth is falling. With falling energy prices leading to a drop in both CPI inflation and BoE future inflation expectations leading to comments signalling an intention to soften monetary policy should the UK economy slow down significantly. However, in reaching the BoE’s decision to leave UK interest rates at 5.25% in December for the third consecutive meeting we saw continued pushback against rate cuts from most MPC members.
Nevertheless, the market is pricing in at least three cuts for 2024, with the first cut of 25bp by June 2024.
Looking at duration, market volatility is likely to create opportunities over the coming six months. We are looking to selectively increase duration to lock in higher yields for longer, without compromising exposure to covered bonds and the liquidity ladder.
Stuart Taylor, Senior Fund Manager, UK Equities
Nigel Kennett, Senior Fund Manager, UK Equities
In our view, the UK economy won’t be hit as hard as feared in 2024; we believe that a soft landing can be achieved. A key reason is that UK consumers (who represent the majority of GDP) have been more resilient than most people think. Wage growth has been strong in the UK – more so than elsewhere.
Inflation is also starting to cool globally, while the recent sharp fall in oil prices is also likely to have a further downward influence which would be positive for real wage growth. Therefore, it’s quite possible that wage growth will be positive through 2024, which is good for confidence and consumer spending.
One of the notable headwinds for the UK economy is the switch to higher mortgage rates for many consumers. However, although that will certainly be painful for a cohort of homeowners, for most it is likely to be manageable. Also, two- and five-year swap rates are starting to come down, so we might start to see a corresponding downward trajectory in two and five-year fixed mortgage rates.
In terms of how this translates to our positioning entering a new year, the UK equity team values the utilities and healthcare sectors over consumer staples within the defensive part of market. We also had a modest overweight to energy that we have neutralised slightly given the fall in oil prices.
Both the WS Canlife UK Equity Fund and the WS Canlife UK Equity Income fund are overweight financials in what is a large and diverse section of the UK market. We are modestly overweight banks that would benefit from a positive or stable environment in the UK economy.
The WS Canlife UK Equity Fund is overweight consumer discretionary, as we believe the consumer will remain resilient. The fund is predisposed towards high quality companies with strong growth prospects. These companies can still perform well should the economy turn out to be weaker than we expect.
In the WS Canlife UK Equity Income fund, the dividends offered by UK companies form an important part of the investment proposition. The fund is therefore more heavily weighted to stocks with higher dividend yields, such as those in the insurance, energy and mining sectors.
There is a lot of value to be found at the moment in UK equities; the UK is currently a very cheap market, with several companies having been taken over at large premiums to their market valuation. Our focus remains on buying good companies, and we are reasonably positive for next year.
David Arnaud, Senior Fund Manager, Fixed Income
KJ Sinha, Fund Manager, Fixed Income
We are expecting a slowdown in 2024 owing to the effects of the lag in monetary policy – we are yet to feel the full effects of rate hikes, although we have already seen slowing growth in the major European economies. However, we think the slowdown will be fairly shallow, with inflation returning to target without a significant economic deceleration. This scenario should enable central banks to deliver rate cuts from the later part of 2024.
We are starting to see consumers, however, coming under pressure; in terms of their higher borrowing costs, there has been a rise in credit card and auto loan defaults (both leading indicators). Also, the theme of accumulated Covid savings that have hitherto supported consumption (particularly in the US) is coming to an end. Meanwhile, the growth in wages seen in 2023 is unlikely to repeat in 2024 as the effects of monetary policy exert downward pressure on inflation.
For the corporate sector, the first part of 2024 is likely to be challenging; demand has slowed and the weaker economic backdrop do not support the same price rises that were possible in 2023.
Companies, particularly in the lower part of the high yield market, haven’t yet felt the full extent of higher borrowing costs, with treasurers electing instead to defer new debt issuance. Investment grade companies that have previously built liquidity buffers are, however, in a better place to weather a potential recession.
Corporate weakness is also likely to trigger a slowdown in the job market. Unemployment hasn’t heated up this year as companies have generally elected to hoard staff due to some fears around the ability to rehire people once headcounts have been reduced.
As 2024 will be challenging for corporate credit, our positioning will focus on the higher-rated, more defensive issuers. We like high quality corporate bonds with low default risks. We like the carry opportunities in the financials space, particularly insurance, which is usually a beneficiary of higher rates. These are likely to have robust capital liquidity buffers entering 2024. The stresses in the US regional banks earlier in 2023 sent a warning shot to the sector – which is now in a better position than the wider corporate world.
Conversely, we will avoid the cyclical names that are lower-rated and are likely to have higher refinancing needs (such as those in the hospitality, retail, property sectors and the weaker utilities such as water companies).
Currency movements will be linked to the actions of central banks, and we currently favour a mild softness of the US dollar. We believe that 2024 is the year where holding duration is going to pay off, and that returns are going to be positive on the back of this shift lower in yields.
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
Due to the underlying assets held, the price of the WS Canlife UK Equity Fund and that of the WS Canlife UK Equity Income Fund are classed as having above average to high volatility.
This page is for information only. It does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the funds must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available in the Literature section for each fund.
Promotion approved 03/01/23
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