Markets are in denial that there will be another growth/value rotation later this year, according to Lazard Asset Management’s Alan Custis (pictured), who said monetary policy tightening and rising bond yields could be set to benefit cyclical UK stocks. 
The manager, who heads up the four FE Crown-rated Lazard UK Omega fund, is therefore overweight oil & gas and financials relative to the broader market, despite widespread fears surrounding Brexit-related uncertainty.
In fact, Custis believes a rotation out of quality growth stocks into cyclicals this year would make more sense than the rotation seen last year, which was partially driven by the election of pro-fiscal stimulus Donald Trump as US president.
“Everyone is in denial on the rotation, but I think the rotation into cyclicals, value and/or economic growth-related names is happening,” he said. “It seems to be as clear as mud that that’s what the market is going to do.”
Last year’s market rotation swiftly snapped back during the first six months of 2017, with the MSCI United Kingdom Growth index almost tripling the total return of its value counterpart.
This gap has started to narrow over the last three months though, as UK gilt yields have risen and the Bank of England has begun to tighten monetary policy.
Performance of indices in 2017
Source: FE Analytics
“To me, it feels like a re-run of last year again. Bond yields have started to march up and this time perhaps for slightly better reasons than before – we are now in an actual tightening environment rather than anticipating the tightening environment, which was the case back then,” Custis explained.
“We are still on the synchronised global growth story at the moment so therefore bond yields and monetary policy tightening are no longer supporting the bond market. If we put those things together it’s actually still not a bad backdrop for equities,” Custis explained.
In terms of UK stocks specifically, the manager doesn’t expect the FTSE 100 index to finish the year on the heady heights seen in 2016 when it gained 19 per cent.
That said, he believes the index – which is up by 5.55 per cent year-to-date – could finish the year up 10 per cent as UK economic fundamentals improve.
“Europe has obviously done a lot better – but I think after last year, and with Brexit, I don’t think we had very high expectations of the UK repeating last years’ performance,” Custis said.
“That was always going to be a challenge. But, I can quite easily see us making more gains between now and Q4. I also think the mix could be quite different to the diet we have been fed on so far.”
Given the current economic environment and the impact this could have on markets, the manager believes oil & gas and financial sectors will thrive while consumer staples and utilities will struggle.
Despite the oil price reaching $59 per barrel for the first time in more than two years, Custis said a lot of investors tend to be underweight the sector relative to the index.
“We’ve been long oil all year and I think it’s fair to say that it’s taken a lot longer to rehabilitate than we would have thought, because we’d have probably been having this same conversation this time last year,” the manager admitted.
Performance of index over 2yrs
Source: FE Analytics
“But, I think there are genuine reasons to be more constructive now; inventory levels have now normalised back down in comparison to the bloated inventories which existed this time last year.
“So, everything seems to be normalising a bit – obviously a lot will depend on OPEC’s commitment to containing output discipline. Everybody benefits from a higher oil price in OPEC, so we shall see.
“If it holds up at this mid-50s level, I think everyone is going to be surprised at how the larger oil companies have re-engineered their businesses to be cashflow positive in a lower oil price environment.”
Oil giant BP is now Lazard UK Omega’s largest individual weighting at 7.25 per cent. At the end of last month, it was the portfolio’s third-largest holding at 6.1 per cent.
Meanwhile, Custis is underweight Shell relative to the benchmark, although this is because it accounts for a significant portion of the index.
“At the moment, it’s 7.8 per cent of the FTSE and there is no point retaining essentially a neutral position,” he explained.
“So, what we have done instead is buy a big position in Weir, that’s a top 10 position. We have some other stocks which we know play along with oil too. So, we’re long oil, we’re long materials and we’ve been buying financials as well.”
While oil and mining stocks are performing well, the manager said financials have yet to respond to policy tightening or rising bond yields.
That said, he believes the market area is set to do well over the medium-to-long term and that it is simply a case of being selective.
“Financials is one area which has behaved poorly so far this year relatively speaking,” Custis continued.
“Banks have been better but financials generally have struggled. If we have bond yields going up and interest rates potentially going up, that’s not a bad backdrop for financials.
“I think financials could go quite a long way with that as a backdrop, despite the fact the market is still undecided about the merits of financials.”
Generally speaking, the manager is positive in terms of finding new opportunities within the UK equity market. This is despite the fact many investors – including Rathbone’s David Coombs and Royal London’s Trevor Greetham – are underweight the market area due to Brexit fears.
“The UK is not an expensive market relatively speaking because it does have a lot of legacy industries represented in it, such as mining, oil and gas,” Custis said.
“Certainly more recently we’ve put more capital to work in areas such as oil and financials and, at the margin, we’ve taken some money off of the table in staples and healthcare.
“We’ve got lots of things bubbling under the surface at the moment. There are quite a few opportunities.”
Since its launch in 2005, the £168m Lazard UK Omega fund has outperformed its average peer and benchmark by 24.46 and 21.99 percentage points respectively with a total return of 170.85 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
It has a clean ongoing charges figure (OCF) of 0.8 per cent.