Over the first quarter of 2024, Square Mile’s team of fund analysts conducted 176 interviews with fund managers running a wide range of strategies representing all major asset classes. As would be expected, there was some variance in views given the differing mandates under discussion, however, the following topline observations reflect the overall tone of these conversations.
UK equities
The UK market rallied reasonably well over the last two months of 2023, with mid and small-cap stocks leading the way. This abated in January and February, but March saw a return to form for large and mid-caps, and to a lesser extent small-cap stocks and AIM names.
Overall, valuations are still very attractive relative to other equity markets, particularly the US.
Within the UK, small and mid-caps are trading on sizeable discounts to large-caps and managers focused on this area of the market are optimistic on future returns given current valuations.
Fund flows into the three main UK equity sectors remain muted, though there is some evidence that outflows are slowing. Managers are hopeful that this reduction in outflows is being viewed positively at a time when investor sentiment towards the UK remains subdued.
However, managers have remarked that the launch of the British ISA is unlikely to be the catalyst for fresh investment into the UK that it was hoped to be.
While there are some specific issues on a company-by-company basis, for the most part, firms are reporting solid earnings numbers, representing limited overall concerns around operational performance.
Broad expectations are for interest rate cuts in late summer or early autumn which should be a positive for more domestically orientated businesses, particularly those within consumer-related areas.
With a General Election likely later this year, there is limited nervousness around the political backdrop, as most expect a comfortable win for the Labour party.
European equities
Europe remains attractively valued versus other developed markets with some well-known fund managers highlighting the strength of consumer and corporate balance sheets and easing inflation.
They note that the region is home to several global companies that are exposed to important secular growth opportunities both within and outside of the region such as the demand for computing power and semiconductors, the clean energy transition, biotechnology, consumer affluence and luxury products.
This means investors with a long-term horizon can access a range of world-class, leading companies at attractive valuations levels.
US equities
A combination of slowing inflation, expectations of interest cuts and the threat of recession abating means that sentiment towards risk-assets has improved, particularly small and mid-cap stocks.
Managers with a large-cap bias have tended to favour quality companies. This reflects the view that, while interest rates may fall, they are unlikely to be close zero, and therefore prudent balance sheet management will be important.
Artificial Intelligence (AI) investment remains a key market driver and continues to support some mega-cap stocks, with NVIDIA’s valuation, for example, still looking reasonable on forward earnings expectations. Some managers believe AI will lead to market leadership broadening out as companies adopt and integrate this technology.
In the nearer term, the upcoming presidential elections add uncertainty. Trump’s return to the White House may lead to policy changes, which could further detract from certain sectors, such as renewables and increase the risk of further geopolitical issues.
Emerging market equities
Managers running emerging market mandates have grown more positive on markets such as Brazil and Mexico, which look set to benefit once the Fed cuts interest rates.
The strength of the technology sector has led to sustained demand for semiconductors, which is favourable for markets such as Taiwan.
Additionally, several managers note that the manufacturing sector in regions like South Asia is attracting greater investment from international companies seeking to diversify globally, driven by wage differentials. Overall, this trend bodes well for emerging markets, which now play a more significant role in US imports than previously.
A key challenge remains in restoring confidence among international investors in emerging markets, which could in turn significantly impact corporate confidence and overall market stability.
Interestingly, it was highlighted that investors are now beginning to question their low exposure to China as valuations are heavily discounted due to geopolitical concerns and the general disappointment of its economic growth.
Fixed income
There is a sense that bonds are back in favour stemming from a trend towards a lower correlation between equities and fixed income assets.
While outlooks are mixed among fixed income managers, on the whole, views are softening on the likelihood of an economic recession and its depth should one occur, rather than the expectation of an outright economic slowdown.
This is reflected in economic data that has been more resilient than many managers were anticipating, however, some stress signals do remain.
Inflation is falling and rate cuts are anticipated albeit in less quantity and frequency than previously expected, due to the strength of data releases over recent months.
Extremely tight spreads have led to a focus on locking in higher yielding assets. Managers are largely overweight duration to varying levels and favour sovereign debt. However, views are split on credit risk, with some exerting caution and preferring higher quality investment grade bonds, and others growing more sanguine and are skewed towards high yield corporate debt.
Multi-Asset
Multi-asset managers have been expressing a broad spectrum of views, with some convinced that a recession will eventually come, whilst others believe a soft landing to be the most likely outcome. This has led to a cross section of risk positioning across managers running flexible strategies.
The consensus is that fixed income assets remain attractive following the yield reset, with many managers finding attractive opportunities at the short end of the yield curve.
Stylistically, managers are favouring higher quality businesses, while harbouring concerns over the valuations of some mega-cap US stocks.
