Finding a positive narrative

Finding a positive narrative

Is there any upside left to equities? Investors are becoming used to a very different pattern of market behaviour this year. Volatility picked up and the super low interest rate environment of 2017 is now little more than a distant memory.

Although we become used to markets bouncing back quickly after corrections, they failed to do so this time around, and the current drawdown is the third-longest since the financial crisis.

While I think there are pockets of opportunity across markets, it is difficult to see significant upsides across entire asset classes, particularly in the US. Investors are likely to be better rewarded by digging down into markets to find value and focusing on areas that offer an asymmetric risk/return balance. The following three ideas identify areas where I see value, even if patience is required in the currently volatile environment. 

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Energy stocks

Oil prices rose substantially the past nine months, with stronger global demand and production cutbacks by Organisation of the Petroleum Exporting Countries succeeding in draining the world’s oil glut. But energy equities lagged the oil price move, as concerns about the revival of US shale depressed sentiment towards the sector. This narrative is changing, with shale oil beginning to run up against capacity constraints such as limited pipeline space. I continue to believe energy stocks offer attractive value and the sector also acts as a useful hedge against geopolitical risk.

European financials moved sideways after a sharp rally as 2016’s fears of global deflation moved into the rear-view mirror. This left many bank stocks still to price in the fundamental improvement in the eurozone economy. Importantly, stronger growth allows banks to dispose of non-performing loans — not only by marking up the loans but also through selling these assets to external buyers. This should help banks to make more efficient use of their balance sheets and drive profit growth. While rate rises from the European Central Bank will also be a strong tailwind to earnings, it could be more of a 2019 story. Nevertheless, it should provide ongoing support for a positive narrative of European banks.

European telecoms

European telecoms performed poorly in recent years, with companies forced to invest large amounts of capital into their businesses. But the benefits of this investment are now coming through as companies are able to offer higher- value services to customers that generate more profit. This should allow telecoms companies to return substantial cash to investors. There is some evidence that value investors are beginning to turn positive on the sector. While some of these sectors found favour in recent months, investor sentiment proved fickle to them in the past year. That’s ultimately proven to be a bonus, as it provided plenty of opportunities to add on weakness — even as the fundamental investment case has grew stronger.

That attitude towards adding on weakness should form part of investors’ wider strategy too, particularly for defensive assets such as US Treasuries as we enter the later stages of the market cycle. While I think we have probably seen the peak in broad markets, there are still opportunities within sectors. Focusing on these more conservatively valued areas, while building in portfolio defence, remains my strategy and represents a relatively ‘safe’ way to take risk.