Neil Birrell
Chief Investment Officer
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
In favour; protection against equity market downside
As I write this the NASDAQ 100 Index is up around 27% and the S&P 500 Index is up around 10% year to date (as at 22 May 2023). These are very sizable moves given the fraught economic conditions we have been experiencing, but quite easily explained. The large US technology and communications companies, or the FAANGs (and related companies) as they are often known as, have been driving market indices. The rise in their share prices has been eye-catching and the valuations they have reached are eye-watering.
In the recent round of company results for the first quarter, it was noticeable that if any of these companies referenced “AI” or “the cloud” it was considered to be nothing other than great news and pushed share prices even higher. In the long term, this may well all be very good news, but for now, there is a lot of hope being priced in.
If you look at the rest of the US stock market, it is a very different story. It has been left behind and it is reasonable to expect the gap to narrow, although when that will be is less clear. It should be expected the gap will close, either with the valuation of the FAANGs falling (and the share prices falling), the others rising or a combination of the two; the latter of which is the most likely in our view.
Given the high proportion of the indices that these companies make up, we have added to the portfolio hedges across the range of funds. We have used put option strategies on the NASDAQ 100 and S&P 500 indices to implement the approach. The existing hedges had lost value as the indices had risen.
Why are we doing this now? There are a number of reasons;
- We believe this is an attractive entry point.
- The cost of the put options is cheaper as a result of declining volatility.
- The outlook for equities has many headwinds, including; declining corporate profits, potential recession, ongoing higher inflation, possible disappointment over interest rate cuts.
- US government debt ceiling worries.
- Tighter credit conditions.
Simply;
- We’ve taken advantage of timing to add cheap hedges at better entry levels (continuing the active management).
- We now have a portfolio of hedges spread over different maturity dates and market levels.
- We see a number of reasons to be concerned about market/equity index valuations given the strong recent performance and headwinds.
Out of favour; the “macro”
It feels like all we have done for years is talk about the “macro”, it seems that it has been the “macro” that has driven asset prices since the global financial crisis and particularly in the COVID and post COVID periods.
Macro-economic factors (interest rates, inflation, economic growth, employment, consumer spending, fiscal policy etc etc etc) are all clearly very important and we have become avid watchers of all the data released. But they tend to drive asset prices at a high level and the fundamentals of individual companies (such as profitability, dividends, cash generation and management decisions) can get overlooked, as do specific attributes of bonds and other assets. Good companies producing impressive results and making good decisions are often not getting rewarded.
My hope is that, as we go through the peak in interest rates and inflation and the economic outlook becomes clearer, fundamentals will play a bigger part (again) in driving asset prices. That would aid active managers and provide great opportunity.
