Gervais Williams, co-manager of the Premier Miton Diverse Income Trust and MicroCap Trust shares his thinking on how the global economy and markets might perform in 2022.
To date, ongoing stock market appreciation has been driven by a mix of premium global growth, which has been principally driven by the rapid growth of the Chinese economy and the appreciation of asset valuations, which has been driven by declining long-dated bond yields. When stock markets rapidly appreciate, often the best performing stocks are those with the greatest volatility. Typically, these high-Beta stocks as they are known, are either growing faster than others, or those with geared upside potential due to major debt.
Going forward for 2022, we believe the current slowdown in the Chinese economy will prove to be structural in nature. Just as happened in Japan in 1989, China’s giant debt burden combined with its aging demographics will lead to a sudden cessation of its growth trajectory, in our opinion. Alongside, after the pandemic stimulus, long-dated bond yields are now close to zero, so they have very little scope for any further appreciation in asset valuations either. At some point, the favourable valuation trend could even start to reverse.
During 2022, we anticipate that these challenges will become more apparent, which could initiate a long period of high-Beta underperformance. At a time of rising wage pressures and borrowing costs, companies with negative cashflow that are reliant on the stock market for funding, or those that turn out to be over-levered, tend to be particularly vulnerable.
Meanwhile, companies that have the potential to generate cash surpluses each year, such as equity income stocks have a natural advantage during more unsettled periods. Their surplus cash can be used to acquire over-levered, but otherwise viable, businesses from the receiver, so as things get worse, sometimes their ability to generate plentiful cash actually improves, contrary to the general trend.
The US stock market is a good example of a stock market dominated by high-Beta stocks, and the equity-income dominated UK stock market is a good example of low-Beta one. As the multi-decade trends evolve from favouring high-Beta stocks, to low-Beta stocks, we anticipate that the UK stock market will cease underperforming the US indices and reverse the trend over the next couple of decades – as happened previously. We believe the Diverse Income Trust is well placed to continue outperforming the improving UK trend if this were to occur.
In contrast, younger companies often have a natural advantage during more unsettled periods. Their demand is typically related to immature markets, that are driven by structural trends rather than the fluctuations of the global economy. Many of the holdings in the Miton UK MicroCap Trust are younger businesses with what we consider to be ongoing growth potential, even if the trajectory of the global economy declines.
Furthermore, being quoted, micro-caps have access to institutional capital that can fund acquisitions of over-levered, but otherwise viable, businesses from the receiver. Hence some quoted micro-caps actually thrive during more unsettled economic periods. We believe the prospects for the Miton UK MicroCap Trust remain strong, even if the prospects for asset markets, and the global economy become more unsettled in 2022. During similar conditions in the past, the same pattern was evident, when UK quoted micro-caps notably outperformed all other areas of the UK stock market.