Top investors name reasons for investors to be cheerful

While there’s no shortage of risks threatening to send stock markets plunging, there are reasons for optimism for those who keep their eyes firmly fixed on the longer term. Faith Glasgow reports.

In years gone by interactive investor has asked fund managers to look ahead to the autumn and tell us about the issues most likely to give them sleepless nights.

This year, we start from a rather different position, as there’s no shortage of misery for many in the UK and beyond. With inflation already above 10% and set to rise further, real wages declining at a record 3% over the second quarter of 2022, widespread public sector strikes, continuing interest rates hikes, and painful stock market losses across most sectors.

So we’ve decided to change tack to request some positive perspectives instead from the experts - all of them running funds from interactive investor’s Super 60 and ACE 40 shortlists.

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Perhaps surprisingly, some of them were really quite chipper. UK fund managers certainly have the comfort blanket of a relatively resilient FTSE 100 compared with the rest of the world. But Hugh Sergeant, who manages ES R&M UK Recovery fund, believes there are actually lots of things to be positive about in the UK. 

‘Inflation not necessarily a disaster for businesses’

Sergeant explained: “We have recovered from Covid. Unemployment is low. Households have strong balance sheets, as their asset values have gone up and they have not binged on credit since the financial crisis. Wages are going up, albeit less than inflation.

“Governments are committed to supporting economies. Banks are in decent shape. Interest rates are rising, but only to more sensible levels. Companies are decently profitable, with strong finances and low valuations.”

Sergeant agrees that inflation is an unavoidable problem; but he adds: “The cure for high prices is high prices.”

In other words, price rises tend to dampen demand and thereby lessen the likelihood of further rises.

Richard Marwood, manager of Royal London UK Equity Income, makes the additional point that inflation, while it is a huge concern for consumers – especially those on low incomes – is not necessarily a disaster for businesses.

“Many companies are putting prices up and controlling internal costs, and their profits are staying the same or growing,” he notes. “In the corporate results we have recently seen, most businesses are coping OK.”

Marwood notes that there will be casualties - businesses where margins are squeezed and demand drops off as prices rise – but he makes the point that “a lot of companies are going to be absolutely fine”.  

Job Curtis, manager of the City of London (LSE:CTY) investment trust, is distinctly more downbeat about the economic backdrop of inflation and rate rises. “Overall, it is not a happy position for the UK and overseas economies,” he warns.

However, Curtis points out that investors are not powerless in the face of inflationary pressure. He flags up companies that to varying degrees benefit from inflation, such as those in the oil sector, miners, utilities and real estate investment trusts.

“There are also companies with strong pricing power, which can pass on inflationary cost pressures, such as in the consumer staples and tobacco sectors. In addition, rising interest rates are a helpful tailwind for some sectors, such as banks and life insurers,” he adds.

Plenty of bargains and dividends are back

Most importantly, says Sergeant: “There are some amazing bargains out there. The UK and global stocks that make up our hunting ground are really very cheap now.”

Marwood agrees. “One of the key attractions of the stock market is that prices have gone down, especially small and mid-cap shares, which have fallen 10% to 15% this year. So things look better value.”

For Marwood as an equity income investor, there is also good news on the dividends front. “Having had a hideous year in 2020, dividends started to recover in 2021 and they’ll be higher still this year. The market overall yields almost 4% now, which is very attractive compared to cash.”

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And that’s a further potential fillip for the UK market, adds Curtis, also a dividend investor. He says: “I am optimistic that UK equities can rerate further, given generally satisfactory profits and dividends reported by companies in the recent six months results season.”

For Ollie Beckett, portfolio manager of The European Smaller Companies Trust (LSE:ESCT), any cause for cheer is primarily to do with focused opportunities in dark days. The recent bear market rally “has done little to dispel the market expectation, exacerbated by dire consumer sentiment, that European economies are heading for recession in the second half of 2022”.

But against that, in Europe as in the UK, valuations have also become more attractive for investors with a medium-term perspective. “For example, the MSCI Europe Small Cap index fell to a price/earnings ratio of 15x in July compared to 22x in 2021.”

There are also specific interesting areas that have suffered less than others, such as the renewables industry. Says Beckett: “The steady move towards net zero, compounded by the desire to decrease dependence on Russian gas, both contribute to a growing need for investment in that area. Similarly, growing pressure for Western countries to move their supply chains closer to home also leaves room for further investment.”

Moreover, he adds, while there is little expectation of any imminent end to hostilities in Ukraine, the possibility of a ceasefire “could have an instant impact on reducing both energy prices and subsequently inflation, as well as provide a much-needed boost to consumer sentiment”.

Tech and growth stocks now have cheaper price tags

Growth managers are tending to focus on the longer-term stock-specific opportunities thrown up by this year’s “indiscriminate sell-off” across tech and other growth stocks. At Liontrust, head of the sustainable investment team Peter Michaelis argues that “for those investors taking a longer-term view, what happens in any particular year becomes insignificant in the fullness of a company’s lifetime”.

As an example, he points to Liontrust’s holding in train ticketing business Trainline (LSE:TRN). “We see it as enabling a cleaner, more efficient and less-congested transport system and therefore exposed to strong long-term growth – but, as you’d expect, Covid lockdowns saw near-term revenues disappear and a dramatic fall in its share price,” he says.

Feeling that fall to be overdone, Michaelis and his team added to their position in the company, since when the shares have recovered strongly as the UK has started travelling more normally again.

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Music streamer Spotify (NYSE:SPOT), Masimo (NASDAQ:MASI), a maker of patient monitoring technology, and sustainable package manufacturer Smurfit Kappa (LSE:SKG) have all similarly sold off heavily despite their strengths as businesses, and therefore offer “significant upside potential” over the next few years.

Michaelis is also excited about the opportunities for sustainable solutions to global problems. “A key part of our investment philosophy is that companies that help solve problems and try to develop more sustainably, and whose products and services we really need, will be more successful than those fighting against these positive trends. Through this lens, we find many companies giving us reasons to be positive.”

The healthcare arena is a prime example. The traditional healthcare model has a large element of trial and error, with people seeking help when they feel ill and hoping their prescribed treatment is effective. In contrast, Michaelis says: “We are moving towards a more personalised system where we can understand how someone’s genetic make-up leaves them vulnerable to certain diseases, and this is opening up new ways to counter conditions such as cancer, dementia and Parkinson’s.”

James Budden, marketing director at Baillie Gifford – a committed long-term growth investment house – agrees that the focus has to be on “companies looking for a better way”, and their potential for success in a rapidly evolving future. 

Budden says: “We’re getting better at understanding the genetic causes of disease and at tailoring therapies to the patient. The cost of the gene sequencing that enables this has collapsed, thanks to firms such as Illumina (NASDAQ:ILMN).

“Along with telemedicine, turbocharged by the pandemic, it points to a massive disruption of healthcare, so assuming the continued dominance of today’s ‘big pharma’ makes little sense.”

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The potential for evolution and transformation is equally uplifting for Austin Forey, manager of JPMorgan Emerging Markets (LSE:JMG). Growth opportunities in emerging markets are driven partly by large-scale trends such as urbanisation. "A growing middle class of increasingly wealthy consumers is already driving changes in consumption patterns that, over time, are independent of market cycles,” he comments.

The technology revolution is another positive development he is watching. “Emerging markets are home to many innovative companies that are leap-frogging Western companies through technology, or that have unique business models that don’t yet exist in the developed world.”

Forey maintains his job is no longer about using developed markets as a road map for emerging markets’ journey. “Innovation, disruption and change mean you can find emerging markets businesses that didn’t exist 20 years ago that are fast becoming global leaders.”

Clearly, these are difficult and worrying times for private and professional investors alike. Nonetheless, there are reasons to be cheerful for those who take advantage of the current wealth of well-priced opportunities and keep their eyes firmly fixed on the longer term.