By Vincent Ropers, portfolio manager, Wise Multi-Asset Growth
Market participants like to focus on milestones. While some these can appear arbitrary, they are worth mentioning because of their impact on the collective psyche. In May, the S&P500, the index of large companies commonly used to track US equities, entered a bear market.
This is the expression used to describe a fall of 20% or more from the previous peak – and the opposite of which being a bull market, describing a bounce of at least 20% from the previous trough.
Recently, the index registered a 20% fall since its all-time-high at the start of the year, recalling bad memories from previous bear markets, such as the Covid crash of 2020, the Great Financial Crisis of 2007-09, the Tech bubble burst of 2000-02, etc
,. None of those experiences were pleasant ones but it is worth highlighting that each one of those bear markets had their own drivers and peculiarities.
Active investors can unearth alpha
While we are not attempting to predict the future, the current environment certainly is unusual. The world is seeing high inflation taking hold caused by the conjunction of supply shocks (Covid, invasion of Ukraine), a strong economic rebound and years of extremely accommodative financial conditions.
While fighting inflation is now the first priority for central banks whose actions, in turn, risk triggering a recession, we are entering a very atypical scenario which could see negative real GDP growth (growth stripped out of inflation) but positive nominal GDP growth (growth including inflation). Such an environment, while tricky to navigate, should allow some companies to grow their earnings and thus present attractive investment opportunities.
This is a very different situation from, say, the 2007-09 Great Financial Crisis when huge levels of debt had to be unwound, unemployment was rising and consumers did not have spare cash to spend. What we do know is that bear markets are always uncomfortable and tend to be volatile with numerous false rebounds, thus necessitating caution and diversification, but we are optimistic that current markets present attractive opportunities for active managers like ourselves.
In June, strong inflation data forced the US central bank to hike rates by 0.75%, the biggest hike since 1994, having spent the previous week’s ruling out such a scenario. In the UK, the Bank of England, for now, is keeping a slower pace, hiking only by 0.25% in June, but proved gloomier in its economic forecasts. In Europe, interest rates hikes are now firmly on the agenda for the summer.
Across all three regions, this tightening of financial conditions is necessary to tame inflation which remains stubbornly high, although showing early signs of peaking in the US, while growth data was mixed. In this context, global equities are volatile and struggling to find a bottom. Commodities markets remained well supported and bond markets occasionally display the defensive characteristics investors rely on them for, albeit not in a consistent fashion yet.
Given the current macroeconomic uncertainty and the high degree of volatility, investment trusts which we specialise in tend to see their discounts widening. This typically happens when investors are keen to take their money out without much buying interest from other parties.
Patience will be rewarded
Those movements can be frustrating, particularly when the underlying portfolios are performing well, as is the case particularly with our alternative investments such as private equity. Panic-driven wider discounts tend to be short-lived however, and can present buying opportunities. Take for example, Oakley Capital Investments which saw its discount widen by about 20% since the start of the year despite strong results reported in April, conservative valuations leading to strong realisations and robustness in its portfolio.
Similarly, Caledonia Investments is trading 10% wider than earlier in the year, despite reporting a close to 28% total return last year, driven mainly by its direct private equity portfolio, and announcing a special dividend equivalent to close to 5%. We would think that those sorts of results should put the trust on investors’ radar and help narrow the trust’s discount, but patience is required in the current environment.
The outlook is complicated due to confluence of macro challenges. However, it is in these very conditions that patient active allocators can unearth long-term alpha