Last year saw a variety of long-established investment styles struggle to deliver returns for investors, with defence becoming the key trait investors looked for when it came to equities, and most of everything else shunned.
Since the Global Financial Crisis (GFC) there have been a number of periods when uncertain global macro trends, sometimes with geopolitical uncertainty thrown in, have caused risk premiums for certain types of stocks to spike, and last year was no exception.
From risk to multi-cap, lots of approaches were ignored or put out of favour – particularly late in the year – as the stock market moved to concentrate increasingly on defensive assets.
The global nature of the stock market exacerbates this trend, meaning if somewhere like the US catches a cold (as it did last year) then other parts of the world won’t be able to ignore it.
Last year this all culminated in a sharp sell-off in the fourth quarter, with the FTSE 100 down 10.2 percent but smaller indices down even further.
However, with so many factors struggling late last year as a result of the above, many are now close to – or at – the bottom of their respective cycles.
Below we examine four major investment styles which struggled last year but which could bounce back as the environment shifts.
Risk
In the context of an uncertain economic and geopolitical outlook the market decided to sell anything with any perception of risk attached to it and buy anything with low perceived risk, whatever the price. This high pricing of low risk, and low pricing of higher (perceived) risk is now back to historic highs. We believe there is a bubble in low risk equities and an ‘anti-bubble’ elsewhere.
Value
UK value’s difficult cycle continued into 2018 with value stocks touching a low point of its long-term cycle. However, there is immense opportunity from this point with style spreads having blown out again, and an ever increasing hunting ground of stocks on bargain basement multiples of less than 10x earnings. In the UK, a very large number of stocks now trade on earnings multiples of less than ten times, the highest number since the GFC; there is a significant opportunity to own a large number of compellingly valued stocks.
Multi-cap
It is fair to say that small and mid-cap stocks have had a good run over the last few years, in particular those with strong growth characteristics. But last year saw a significant pullback, with de-ratings as a result of share price falls at a time of continued earnings growth. UK small and mid-caps underperformed the FTSE 100 by almost 5%. This has left those stocks no more highly rated than their larger peers, with a correspondingly huge opportunity to find anomalies among such names.
Recovery
Recovery stocks struggled last year, with some of our favourite recovery stocks, in sectors such as oil services, financials and the digital economy, halving. This often happened without any negative stock specific news; stocks were undermined by being seen as too uncertain, and therefore risky. There is now a real opportunity to buy recovery stocks at very low valuations, and many of our favoured recovery stocks are trading at valuations that are bottom quartile versus their history.
The oil services sector, for example, has huge profit recovery potential due to the fact that the depressed oil price over the last five years has materially curtailed investment in finding new oil reserves and increasing the productivity of existing fields. While a new cycle of investment will occur over the next few years, because of the uncertainty over the exact timing of this recovery, valuations are very depressed in absolute terms and relative to history.
River and Mercantile an asset manager which had £33.8 billion of assets under management as of 30 June 2018.
