Professional investors see signs the stock market has bottomed

Despite warning signs about the economy, some investors are beginning to become more optimistic, writes Sam Benstead.

There is no shortage of dark clouds looming over the horizon for investors. These include falling house prices as mortgage rates triple from two years’ ago, rampant inflation that is eating into purchasing power, and slowing economic growth even as interest rates are still rising.

The Bank of England is now forecasting the longest recession in Britain since records began, with a “challenging” downturn that began this summer, potentially lasting until mid-2024, and unemployment doubling by the end of 2025.

While the outlook is frightening, there are a few rays of sunshine beginning to break through the clouds. Last week, better-than-expected inflation numbers in the US sent stock markets soaring, and some investors are beginning to add to riskier stocks and bonds to take advantage of more supportive central banks.

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We caught up with some professional investors to better understand the outlook for stocks and bonds – and asked how they have been adjusting their portfolios.

Peak interest rates aren’t far off

Francesco Sandrini, head of multi-asset strategies at French fund manager Amundi, is growing more confident that the peak in interest rates is not far off because inflation is beginning to slow.

Sandrini said: “We are seeing good indicators that economies are slowing down: car prices are falling in the US, household surveys show lower confidence and the labour market is cooling. This shows that central back tightening is having an impact – and the delayed effect is coming through.”

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This means that he has been increasing “duration” in his multi-asset portfolio, meaning that he is adding stocks and bonds that are sensitive to interest rates and will perform well if rates fall.

“We like government bonds with medium-length maturity dates, as well as investment grade bonds, high-yield and emerging market bonds. The slowing down of economies has already been priced into markets but companies are extremely solid financially as there are very few firms issuing new bonds,” he said.

In the stock market, he said there was “an opportunity to introduce a cautious stance on the equity market”.

Sandrini said: “The lesson from latest earnings results was that large technology companies disappointed, and growth companies generally are fragile. But small companies, such as those in the US Russell 2000 index, have already had the bulk of their correction and could be a better place to invest.”

He adds that European shares are facing more issues than US shares. “In the US, a lot of negative earnings are playing out, but Europe is lagging on this – so there could be more downside in European equities to come, despite falls already this year,” he said.

Overall, Sandrini argues that the outlook is much better now for markets, and normal correlations between stocks and bonds could be restored when interest rates peak.

Another investor growing more optimistic is Dorian Carrell, a multi-asset portfolio manager at Schroders.

Carrell said the outlook is more positive as interest rates are close to peaking. On stocks, he said his team had been negative all year so have been underweight shares, but are potentially becoming positive now – and there could see a rally soon. “Data on inflation is key for deciding on equities,” he said.

In the equity market, he is wary of America’s technology stocks, as well as the S&P 500 index more generally, as its 17 times price-to-earnings (p/e) ratio is still expensive.

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“Valuations could be too high in America, as a 17 p/e is not typical for where are in the economic cycle. The tech sector is under the most pressure, so we are less excited about this part of the market,” he said.

Japan is cheap though and yields 2.5%, which makes it an attractive market, he adds. “We like Japanese exporters due to the weak yen, and there could also [be] a reopening story after Covid as well there,” he said.

Carrell also likes Europe due to its cheaper valuation. “It has been very disliked by global investors, and European shares have an average p/e ratio of just 11. Combined with a 3.7% yield, that is attractive,” he said.

Interest rates will likely stay high, even if they stop rising, which Carrell argues will be good for financial companies, such as insurers and banks.

‘Market reaction is overblown’

But not all investors are positive. Rupert Thompson, chief economist at wealth manager Kingswood, said that even though the US inflation numbers are encouraging, the data is volatile and investors should not read too much into the inflation print at the moment.

“The market reaction looks overblown and is probably explicable by the pessimistic positioning of institutional investors, if not retail investors, who all along have resisted the temptation to sell out.

“The fact is that core inflation continues to run above 6%, has yet to start slowing conclusively, and remains well above the 2% central bank target. The latest numbers will almost certainly not trigger a major change in their stance.”

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But he points out that the midterm elections in the US, where the Democrats did better than expected, could be good for markets.

“The red (Republican) wave failed to materialise with the Republicans likely to end up with only a slim majority in the House of Representatives and the Democrats taking control of the Senate.

“Policy gridlock – which markets tend to like – now looks almost certain. It also changes the outlook for the presidential election in two years’ time. The betting odds now show Ron De Santis, the governor of Florida, slightly more likely to win the Republican presidential nomination than Donald Trump. At the same time, Joe Biden seems emboldened to run again in 2024.”

Thompson also points out that China is introducing measures aimed at improving its Covid control methods.

“While the recent flare up of Covid infections and the approach of winter mean the near-term boost to growth is likely to be limited, it does appear to herald a wider retreat from the zero Covid policy next year, which will be a big deal,” he said.