Investment Line is a regular investment bulletin produced by Mattioli Woods plc. The communication provides an update on funds, highlights some of the areas we are focusing on, and shares our thoughts on the issues of the day.
Markets seem to have regained their poise after the alarming events in the US banking sector. A brief look at the headline indices makes for pretty encouraging reading, though it is difficult to argue that the challenges facing investors have miraculously disappeared. We are now into reporting season in the US, which will give investors an insight into how corporates are faring in the current environment, but we are yet to see company earnings extensively affected by the economic difficulties. This is the case despite the fact there is already significant weakness in some of the leading economic data. The jobs market also looks resilient, though it must be remembered this is generally impacted only after companies run into sustained difficulties and are then forced to lay people off. It may be the case that fear over rehiring staff post the Covid-19 experience is making businesses more reluctant to fire people, but there are certainly recessionary winds blowing.
The Federal Reserve has admitted that a mild recession is probably in the offing, which is unhelpfully unspecific, but still worth paying attention to. What this will mean for a US market still looking less than cheap is not clear, but we are cautious. The chatter among the investment community keeps coming round to the parlous state of sections of the commercial real estate market in the US and the c.$1.5trillion of refinancing due over the next few years. This means a lot of risk still resides in the US banking sector and with regional banks in particular. Stability concerns have got to be weighed against adequately dealing with inflation (which is coming down as expected) but there is still a stickiness to the numbers that justifies the Federal Reserve in pushing through some additional hikes if they remain that way inclined. It really is an unenviable task, but the data is not suggesting it is about to get any easier. For now, they appear to still be on a mission to control inflation (a rate cut by the end of the year is now seen as less likely than it was a month ago) and this probably means more things will ‘break’ in the system. Facing a non-trivial chance of a recession in the US and elsewhere, there is just too much uncertainty around to justify adding risk to portfolios at this time.
Reducing the level of equities in a portfolio is of course not the only way of reducing overall ‘risk’. We can also change the nature of the equity exposure and the style of investing. Equity income offers some security in times of uncertainty, with a large part of the universe focused on larger cap companies with strong cash flows and resilient business models. This sounds attractive to us at the current time, as inflation remains a problem and interest rates stay high. Those companies best able to maintain or increase margins in this environment are naturally attractive and if the economic backdrop does deteriorate, they are often able to fare better than others. Though it is true that decent returns are now available from bonds, the increased importance of yield means the equity income sector should remain in demand and the pricing power of corporates means lower vulnerability to inflation than many alternatives. Accordingly, we are introducing a global equity income allocation in some of the portfolios to give us some additional protection without having to significantly reduce overall equity exposure.
Click here to read our thoughts on asset allocation.
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Investment Line is written and edited by Chief Investment Officer Simon Gibson and Investment Strategist Richard Smith and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.
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