Head of Research and Deputy Head of Premier Miton’s multi-asset multi-manager funds
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.
Market reporting, analysis and commentary have a general tendency to promote myopic attention toward the latest data release. It feels that such releases are having an outsized impact at the moment given the data volatility providing no definitive direction to follow. Consequently, market sentiment continues to gyrate as each new release challenges and contradicts the assumptions and convictions derived from the previous one.
In Lewis Carroll’s Alice in Wonderland, Alice finds herself in a strange world where up is down, wrong is right. Given our limited clarity on the current economic environment, determining future expectations with any degree of confidence has seemed not dissimilar to Alice’s distorted journey. Much like Alice in the realm of the Cheshire Cat, investors today find themselves in a world that defies many investing common laws, where the only certainty at the current time, appears to be uncertainty.
“Nothing would be what it is because everything would be what it isn’t’’.
Lewis Carroll’s mad hatter could have been talking about the peculiarities of stock markets today when an odd feature is that sometimes good news is the last thing investors want to hear, while bad news is seen as a positive. Since the start of the year, such contradictions have been in full flight. January saw a further slowing of interest rate rises by the US Central Bank (moving from 0.75% to a 0.5% addition in December, before the rate increase was further reduced to 0.25% in January).
Accompanying this move was data showing consumer spending slowing having adjusted for inflation, whilst core inflation had remained muted.
Investors interpreted this as a sign inflation had peaked, suggesting rates would start their descent by the end of the year whilst avoiding a recession. However, by mid-February data showed an unexpected gain in consumer sales, along with the US labour market data remaining surprisingly strong. Although the improved economic outlook appears to be supportive for company earnings, this shifted investor expectations that rate increases could persist, increasing the chances of a recession as the Fed seeks to tighten policy to rein in the economy in their bid to control inflation.
Perhaps we should not be surprised by the topsy turvy nature of markets
Central banks in the US (Fed) and UK (Bank of England) have already informed markets they are operating in ‘data dependency’ mode. This means policy will be flexible and dynamically adjusted to react to the data releases. Markets are just taking their cue from them! Given this volatile backdrop, what are investors and investment professionals to do?
“Would you tell me, please, which way I ought to go from here?” “That depends a good deal on where you want to get to.’’
Those with a disdain for the gyrations of the market can take their cue from the corporate results and company expectations they are seeing, to remain blinkered to the macro environment. Unfortunately, no company is an island, and they are affected by the macro environment while their share prices are sensitive to the changing tone of markets and within markets. Given the macro ‘noise’, there are several possible courses of action:
Deliberately rein in investment activity
There is some credibility to this option if the fund manager can demonstrate they are emphasising conviction in their portfolio from positioning with a longer-term perspective. This does require considerable discipline to maintain such a stance as portfolio performance will predictably be buffeted from changing market sentiment. The trick here would be to differentiate between managers taking a deliberate active stance, compared to managers who are ‘caught in the headlights’ where inactivity is driven by acute uncertainty and decreased conviction.
React to changing market variables.
Those managers that use the changing economic picture to adjust and reposition portfolios are supported by the Winston Churchill quotation that “When the facts change, I change my mind.” There is undeniably a great deal of intuitive sense from this stance. However, there has always been a fluid relationship between economic data and the sensitivity to how bond and equity markets interpret and respond to it.
This gives rise to what Howard Marks calls ‘second level thinking’ where investors should go beyond responding to the economic data itself and instead seek to understand how much of the news is priced into assets to drive investment decision making.
“Why, sometimes I’ve believed as many as six impossible things before breakfast.”
The changing sentiment of the market has a habit of making even the most intelligent investor look stupid (for a short while), even if they appear to be right. I recall the US presidential election in 2017 being a glaring example of this. At that time, a prominent investor had studied exit polls and swing states and concluded that Trump would win the election, positioning their portfolio accordingly.
The perception, held widely at the time, was a Trump win would be negative for the US market. However, rather than the US market going down on the election outcome, market sentiment flipped and resulted in material gains for the S&P. Even if like the prominent investor you had out analysed the market on the election outcome, it must have been quite galling to have seen losses generated by having a position that was the exact opposite of what was required.
Curiouser and curiouser
Given the current volatile backdrop, an alternative portfolio management strategy that responds to the gyrations of the market, rather than the data points that attach themselves to it, can prove more resilient. This ‘relative trading’ approach allows managers to recycle gains from investments that perform well to those that have lagged. This enables the manager to take advantage of market swings whilst still retaining the broad shape of the portfolio (if desired).
This latter approach is one that we favour and employ. As a result, during periods of heightened volatility across markets, activity across the multi-manager desk has a strong tendency to rise in seeking to take advantage of moves. By employing such an approach, we have been able to consistently demonstrate that attractive risk adjusted returns can be achieved from an active approach to investment management.