Being a good investor not only means knowing where to invest, but especially where not to.
Going into the new year, managers are treading carefully on a number of terrains, including UK and European cyclical stocks, which were deemed a value trap, US tech companies, US investment-grade bonds and some other fixed-income areas globally, and China.
Rathbones’ Coombs: UK and European cyclicals, the Mag Seven, high yield
UK cyclicals are an area David Coombs, head of multi-asset at Rathbones, has been avoiding since the end of 2023 and will continue to do so.
“They are absolutely awful; they are going to look cheap, but will stay cheap,” he said. “The UK just looks awful at the moment.”
The reason for his pessimism is the potential consequences of the Autumn Budget, which he believes to be stagflationary. To him, it could lead to rising unemployment, fewer investments in the private sector and less hiring.
The revenues that the chancellor expects to gain won't materialise, pushing guilt yields up in the short term and in turn increasing mortgage rates, while companies are going to try to push higher prices through to the consumer, which will prevent the Bank of England from reducing rates. Price rises for the consumer and less employment is not good for domestic cyclicals, Coombs explained, so hospitality, airlines and similar sectors will suffer.
The same goes for European cyclicals, where confidence is also low.
“In Europe, you have got the German government collapsing, the French government collapsing, the Romanian elections having to be rerun – none of this is great in terms of confidence in economic stability or growth,” he said.
“For my view on European cyclicals to turn around, I'd need to see some pretty serious stimulus from China to recharge demand for European capital goods. At the moment, it looks pretty bleak.”
Coombs isn’t sold on many other areas too.
He owns five of the Magnificent Seven stocks, which he has been trimming “very actively” because of price “euphoria”.
These stocks have left the market behind for two years and there is a “very good case for a bit of catch up”, which means they might tread water and underperform for a while.
He also wouldn't be buying credit, corporate bonds, high yield or emerging debt. Corporate bonds offer investors a higher yield than government bonds as compensation for the risk that companies might default on their debt; this yield differential, known as the spread, is at its lowest level since 1998.
“With spreads as narrow as they are, I might as well buy sovereigns”, Coombs said, as other bonds don't give any risk diversification and “don't bring much to the party”. He believes a UK recession has already begun and that isn't great for high yield, which he sold out of.
“If default rates, or even market expectation of default rates, start to rise, then the mark-to-market shifts down in high yield,” he explained. “Where spreads are so narrow over sovereigns, high yield doesn't look very attractive.”
Downing’s Paget: Tech mega-caps
Alex Paget, fund manager at Downing, was also wary of tech mega-caps. For him it's not about avoiding these investments entirely, but about ensuring you don't put all your money into them.
This is not because he doesn’t believe in the artificial intelligence (AI) revolution – quite the opposite, he firmly believes AI will have “a huge impact” on society and the economy. In his portfolios, he holds “excellent funds” such as Sanlam Global Artificial Intelligence, which have a high exposure to the theme.
“However, despite recent investor sentiment, there are no one-way bets in financial markets. Our view is to ensure you are diversified and to see how much of your portfolios have been driven by these names of late because it is feasible that after a strong few years, leading to elevated valuations and decent amount of investor excitement, these high growth, mega-cap tech stocks endure a period of tougher performance,” he said.
“We are not avoiding mega-cap growth stocks or betting on their collapse next year. However, we are not betting the entirety of the portfolio on them, ensuring we hold a balanced mix of differing investing styles which have been somewhat left behind over recent years thanks to the AI-fuelled rally. This is a sensible approach that investors, particularly those who hold a predominantly passive portfolio, should consider as we look to 2025.”
Fidelity’s Rikkerink: US investment grade, European equities
US investment grade bonds are one area that investors should think twice about in 2025, according to Henk-Jan Rikkerink, global head of solutions and multi-asset at Fidelity International.
“Granted, the probability of companies defaulting in the US is currently low due to the relatively strong economic environment. However, spreads are so tight that investors are not getting adequately compensated for this risk,” he said.
Instead, shorter-dated high yield bonds from both Europe and the US offer “a more compelling proposition”.
In disagreement with Coombs, for Rikkerink the yield offered by high yield bonds “represents a better risk-reward trade off” despite the tight spread. He was with Coombs, however, on European equities, another area he cautious about for the same reasons illustrated above.
Jupiter's Lewis and Columbia Threadneedle’s Hewitt: China
In Jupiter’s Merlin team, risk is viewed as the danger of the permanent loss of capital, not simply the inherent volatility, or shorter term price fluctuations, of an investment, investment manager David Lewis explained.
This mindset led him to redeem all of his dedicated Asian and emerging market exposures in 2021, as he did not want to have equity exposure in China. Since then, Chinese equity market performance has been poor, but he continues to believe it is a place best avoided.
“The Chinese government has proven itself willing to change regulations in short order to the detriment of industries and private companies. Minority investors in Chinese companies, as UK investors are, have very little if any influence on the management of companies in China and so the levels of corporate governance are far from those seen typically across the developed world,” he said.
“There may be investors willing to look for bargains in China following the prolonged falls of its markets, but the Jupiter Merlin team is far happier investing in areas where our interests are aligned with company management and where state intervention is less liable to disrupt industries at short notice.”
Peter Hewitt, manager of the CT Global Managed portfolio, also no longer has any investment in China-only funds. He doesn’t mind other vehicles that he owns having a percentage of their portfolios in China, but the overall dynamics of the country, including demographics, property and debt, are “not positive”.
“On top of that, China has an authoritarian government, where companies and sectors can suddenly be outlawed. It happened to the education sector a couple of years ago, and then some of the big technology companies lost their chief executives. I would be not be keen on that,” he said.
“I would not say don't have anything in China, because there are some good companies here. Even though the Chinese market and companies are cheap, they should be for all these reasons.”