“And now for something completely different.” It’s a quote made famous by the genius of the Monty Python Flying Circus show from the late 1960s and early 1970s.
I’m sure many of you would’ve heard it – but for those that haven’t, the line was spoken by the announcer (John Cleese) as a way of transitioning from one weird thing to something even weirder in the comedy show.
That’s exactly what we’re dealing with in financial markets at the moment. The narrative for the previous 12 years – from the end of the global financial crisis in 2009 to the end of 2021 – was that we lived in a growth environment of free money and low interest rates.
It was a post crisis incubator created by central banks across the globe – courtesy of quantitative easing – and while there was no inflation in the typical sense of the word, every asset class became inflated in value.
And then there was 2022 – let’s be honest, it was not a good year for investors in the slightest. In the first quarter, I remember reading that every asset class was down for the first time in three decades. The reality is that unless you were heavily into energy, you lost money this year.
We are now in a new economic environment, where uncertainty and volatility seem as rife as ever. One common consensus is that the world is now bracing for recession.
In the past decade just owning growth stocks was all an investor needed to do to make money, and now, all of a sudden, low beta defensive sectors – the likes of miners and oils companies – are looking far more attractive.
The best recession indicator is the inverted yield curve – with the US two-year Treasury note continuing to offer more (4.2%) compared to the US 10-year (3.6%). For clarity, the inverted yield curve has emerged roughly a year before all recessions since 1960.
But I’d argue now is not the time to run for cover – yes things could get cheaper, but many asset classes have been hammered already, to the point where valuations are already looking attractive from a long-term investment perspective.
I also feel inflation may have now peaked and will start to fall back in 2023, although it is unlikely to be near 2% in the UK any time soon.
My final message would simply be to not let uncertainty give way to pure pessimism. Markets have already fallen significantly, but you only lose money if you sell and crystallise your assets. Long-term investors must see through these trying times and recognise volatility is also an opportunity to make money.
With this in mind, here are a few areas I feel offer attractive entry points in 2023:
Old fashioned UK equity income
Things that have looked unattractive for many years are suddenly turning heads – a good example might be traditional UK equity income funds. Once the bedrock of many an investor’s portfolio, these funds have been disliked for the past decade as returns from a value-tilted FTSE 100 have paled in comparison to US tech behemoths such as Amazon and Apple.
Re-investing dividends looks a more attractive solution in today’s world and a good example would be the Artemis Income fund, which currently has more than 80% invested in the FTSE 100.
China
This is the riskiest of the lot – but attempts to tackle Covid and the troubled property sector, coupled with extremely attractive long-term valuation, mean China is becoming interesting again.
Here I’d look to a solid option such as FSSA Greater China Growth for direct exposure or a regional vehicle like Matthews Pacific Tiger fund.
The latter is run by a dedicated team in San Francisco, who target high-quality companies for the longer term. The fund currently has almost 40% invested in China.
Bonds
There have been a dearth of opportunities in the bond market in recent years – but we are now in a scenario where yields are up and prices are down – and that creates opportunities.
Many commentators I’ve spoken to believe inflation is at or near its peak. More importantly, the chances of reaching interest rates in excess of 4% is unlikely given we are in the midst of a huge cost-of-living crisis in the UK.
There is an argument that every sub-sector has its attraction, but the likes of short duration bonds (two-to-five years) – many of which are starting to offer yields of 6-7% – will become incredibly attractive.
The TwentyFour Absolute Return Credit fund invests predominantly in investment grade bonds that are due to mature shortly. It has been designed to be easy to understand and does not 'short' stocks or borrow any money to boost returns. The fund currently has a modified duration of around 18 months.
UK small-caps
Small-caps are always in the eye of the storm, but they have also shown incredible resiliency to any challenges thrown at them, particularly in the UK. Research from Montanaro shows that at 8.6x, UK smaller companies are now trading on their lowest average price-to-earnings (P/E) ratio since 2009. Yet it was as high as 15.9x in December 2020.
Many of these innovative, manager-owned businesses, have shown they can navigate challenging times and come out stronger. A vehicle like the Liontrust UK Micro Cap fund is well positioned to tap into these businesses, as it focuses on firms with profitable, hard to replicate and capital-light models that can scale quickly.
Japan
Another area I’d consider is Japan. There are a number of reasons for this – not least that the domestic outlook is improving as the country re-opens its borders.
Corporate governance and stable politics will also help as does the fact that the Bank of Japan may be the one major central bank that is happy to see some external upward pressure on inflation from energy prices and the sharp weakening of the yen.
A good all-rounder is the AXA Framlington Japan fund, which invests in Japanese companies of varying sizes but tends to have a slight bias towards smaller companies.
Darius McDermott is managing director of Chelsea Financial Services and FundCalibre. The views expressed above should not be taken as investment advice.