Fund managers from Rathbone Unit Trust Management set out their views for 2023
- Alexandra Jackson, Rathbone UK Opportunities Fund
- Noelle Cazalis, Rathbone High Quality Bond Fund
- James Thomson, Rathbone Global Opportunities Fund
- David Harrison, Rathbone Greenbank Global Sustainability Fund
- Bryn Jones, Rathbone Ethical Bond Fund and Rathbone Strategic Bond Fund
- David Coombs & Will McIntosh Whyte, Rathbone Multi-Asset Portfolios and Rathbone Greenbank Multi-Asset Portfolios
- Alan Dobbie & Carl Stick, Rathbone Income Fund
Alexandra Jackson, fund manager, Rathbone UK Opportunities Fund
World class businesses trading on a postcode-driven discount
2022 has been the year of the dot plot. Investors obsessed over the path of interest rates, and tried frenziedly to reprice equities to account for higher rates. The market took the hit. But economies and companies proved resilient; we’ve have barely started to see the impact of all the tightening. This is why there is a huge disconnect between what companies are telling us (in the main, the news is still good outside retailing) and how shares are doing (getting pummelled).
In 2023, economies and companies will finally start to feel the chill from tighter monetary policy. But could markets fare better? Granted, as the narrative shifts towards the degree of downgrades and how weak growth could be, it’s not a classic set up for equities.
The key will be finding those areas that can outrun a slowing economy and earnings downgrades. We firmly believe that the best chances of success lie in a combination of attractive valuations and earnings resilience. On this basis, the UK scores better than almost anywhere else. UK stocks are cheaper now relative to the rest of the world than since the 1990s; this is the only major developed market trading at levels consistent with a recession. A single-digit P/E multiple has proved a good buying opportunity in the past.
Crucially, many of the pressures that have weighed on our part of the market (mid-caps) are dissipating. Sterling is bouncing, interest rates and inflation are close to peak, and stability has returned to government. Add in a quality screen to avoid accident-prone cyclicals with too much debt, and we can see a path through. The coming recession will further separate the world class from the merely parochial, even though right now valuations are not.
While investors are busy searching for the bottom and agonising about a few basis points, someone else will have snapped up these world class businesses trading on a postcode-driven discount.
Noelle Cazalis, fund manager, Rathbone High Quality Bond Fund
Multi-year high yields could offer interesting year in 2023
Yields on offer in fixed income are at multi-year highs. We think it provides an interesting backdrop for the asset class for 2023. The spread widening seen this year, combined with the sell-off in rates, has pushed yields higher. The income investors can draw looks attractive, something that was missing for a few years.
So far, credit fundamentals of high-quality investment grade (IG) companies have been stable. But the market is pricing in default rates for IG, much higher than historical levels. In Europe, the market is pricing in close to a 10% default rate, when the worst it has been since the 1970s is 4%. In our view, this dislocation is likely to correct over the next year, which will be positive for spreads. We believe ‘refinancing risk’ is manageable too for IG companies. Strong fundamentals and attractive valuations lead us to favour credit over government debt.
Rates are likely to remain volatile, especially in the first half of the year. More tightening is expected in the US and Europe until June, and in the UK until the end of the summer. We prefer to remain positioned in the short end of the yield curve, where we believe risk adjusted returns are more compelling. For example, in our fund we need gilts or spreads (or a combination of both) to sell off by 175bp before we generate a negative return. Bonds issued from banks look particularly attractive as earnings and solvency have been robust. However, there are sectors where the outlook looks more challenging, such as real estate companies that continue to suffer from COVID changes and face higher refinancing costs.
With yields north of 5.5% and a duration of 3 years, we believe we are well positioned to generate positive nominal returns in 2023, and that the risk/reward in this asset class looks appealing.
James Thomson, fund manager, Rathbone Global Opportunities Fund
A Fed pivot could be the defining moment of 2023
We’ve had so many false dawns, so many failed rallies in 2022 that the market is training us to believe that any move higher is just another bear market rally. That is why we must abandon the requirement for precision and downside certainty and anchor ourselves to a long-term strategy.
It may not be fashionable, but we are positioned for inflation to rollover and the potential for markets to move sharply higher. We can debate the timing, but it would be triggered by the defining moment of 2023…a Fed pivot.
History tells us that in “inflationary bear markets” such as those in the 1960s, stocks bottom out once inflation peaks, allowing the Fed to pivot away from hawkishness. In the 1960s when the Fed didn’t engage in forward guidance, outright rate cuts were the catalyst to look for. Today it could be a forward guidance signal from the Fed – when the rhetoric starts shifting away from inflation concerns towards growth. And we know that stocks do well after inflation peaks and the Fed changes tack. Following previous post-pivots (i.e., 1970s), the S&P has [on average] rallied by 27% over subsequent 12 months. The rebound is unlikely to be gradual or predictable – the best returns come when you least expect them.
Many growth stocks are unlikely to regain their pre-inflation era multiples. So, whilst we will always invest for the long term, that does not mean we should anchor ourselves to stocks dogmatically, when the future and facts change. Rather than burying our heads in the sand and wishing for a drop in inflation to bring back the old status quo, we have made a number of changes to the portfolio over the past year. We have changed about 20% of the portfolio in 2022, replacing stocks like Uber, Shopify, Align, Match, Signature Bank and Silicon Valley Bank, with higher quality growth, more predictable, resilient and cycle-tested companies, where we believe the strong will get stronger over the coming years. Examples include Apple, LVMH, Home Depot, Boston Scientific, Mondelez, Coke and McDonalds. We would never claim these are unheard of companies but it’s the underestimated potential for revenue and earnings growth; resilience of fundamentals, even in the face of a recession; assessment of growing market share and market penetration, and new addressable market potential that we are assessing to qualify as high quality out of favour growth. These companies have been in our ‘watch list’ for many years, so we have used this sell off in markets to buy some of the best growth stocks in the world which we missed first time round.
David Harrison, fund manager, Rathbone Greenbank Global Sustainability Fund
Events of 2022 have only accelerated the move to more sustainable infrastructure
2023 is likely to be another year of macroeconomic uncertainty. Although there are tentative signs that inflation is peaking and supply chains are improving, there is increasing evidence of a global slowdown in activity. It is unclear whether we will enter a recession across all major economies or indeed be faced with a bifurcation scenario with pockets of stronger growth in certain regions. The role of monetary policy is likely to remain centre stage as central banks try to calibrate their response to the changing environment.
Given the current levels of uncertainty, we believe it remains critical to own companies that enjoy strong competitive positioning. To us, that means good pricing power, robust cashflow generation and management teams that are allocating capital in a sensible and clear way. We believe that the portfolio is positioned in such businesses across various sectors and market volatility provides the opportunity to add exposure to long-term attractive valuations.
We also believe that the events of 2022 have likely accelerated the move to more sustainable infrastructure. Renewable sources of power continue to represent a significant investment opportunity, coupled with the growing need for energy storage solutions and requirement to invest in next generation grid infrastructure. Similarly, we see increased focus on investment in aging water infrastructure particularly in the US and Europe, which is likely to remain steady even in a weaker global economy. As supply chains start showing signs of improvements next year, it could prove beneficial for companies exposed to electrification of the global transport fleet which remains an attractive area of investment to us.
Bryn Jones, fund manager, Rathbone Ethical Bond & Rathbone Strategic Bond Funds
The prospect of more central bank hikes into more restrictive territory will continue to throw buckets of volatility into markets.
It would not be out of place to say 2022 has been a monumental year for fixed income investors, with the fastest rise in gilt yields in my career and indeed for many decades before! Added to this, the widening in credit spreads because of inflationary pressure, cost of living issues and war in Ukraine have negatively compounded poor absolute performance. This has sparked arguments that these factors could lead to negative growth in 2023, which is a possibility.
Whilst the nervousness has been growing, defaults in investment grade (IG) credit have been low. Also, earnings have been robust. Financial bonds have seen strong earnings and excellent solvency. Interestingly, insurance companies have seen their solvency grow to some of the best levels on record, which is juxtaposed to the negative sentiment.
Overall, IG credit spreads have moved out to levels where we see them as oversold considering their better credit quality, and investors are being well compensated for the risks they are taking.
Whilst it is normal to expect that higher borrowing costs – because of higher base rates and higher credit spreads – will lead to higher risks of refinancing risk and defaults, we continue to see strong credit fundamentals in the first half of 2023.
However, uncertainty reigns. With inflation stubbornly high in the UK and US and unemployment still very low, the prospect of more central bank hikes into more restrictive territory will continue to throw buckets of volatility into markets, some of it cold water.
At present, credit markets (and equity, for that matter) view bad economic data as good news as they price in a Federal Reserve (Fed)/Bank of England (BoE) pivot away from hikes when this data hits the screens.
The major concern for credit investors, therefore, is of the Fed and BoE over-tightening. At some point, global growth will shrink, and weak economic data would be taken as that, and we would face a negative reaction from risk markets. Of course, at least central banks would now have enough fire power to ease, because they would be sitting at higher base rates.
The other point to consider is net gilt supply. While this fiscal year has seen fewer gilts issued than expected, next year should see a big increase in gilt supply due to the worsening fiscal picture. Add in gilt sales/quantitative tightening from the BoE, and an unwind of gilt purchases, and it will turn into an interesting story to watch between demand and supply as well as the subsequent impact on gilt yields.
It is difficult to call the overall direction of both rates and gilts for 2023. What we do believe is the extra yield/spread in IG right now compensates investors for the risks of rising rates and/or spread widening. Even with yields rising another 100 basis points from here, we can still generate a positive nominal return. So, we could say spreads tighten or widen, or we could say rates markets will see higher or lower yields, but right now, this is the beauty of IG investing in 2023. The yields on offer look very attractive. Investing in IG credit really plays an interesting part in a balanced portfolio at present.
David Coombs & Will McIntosh-Whyte, fund managers of the Rathbone Multi-Asset Portfolios and the Rathbone Greenbank Multi-Asset Portfolios
Problems of 2022 hang over new year but parting of inflationary clouds possible
2022 has seen a rapid unwinding of a decade and a half of zero interest rates, leaving markets struggling to predict what the cost of capital will be in the next five years.
The new year is sure to be filled with old concerns when it comes to the investment world. The world is adapting to the effects of the war in Ukraine; the energy picture remains complex and uncertain, and we are edging closer to the end of US Federal Reserve’s tightening policy – it will not be a quick return to any normal.
Inflation in the US does look to have peaked, and easing supply chains, higher inventories, cooling house prices and a softer jobs market should start to bring inflation back to more typical levels. However, the Fed appears reticent to ease financial conditions too soon and allow a resurgence in prices. Inflation in the UK looks slightly more structural, with strike action, labour shortages, and questions around the credibility of the Bank of England governor adding to the uncertainty.
Meanwhile, economic data, in the US, UK and Europe, are pointing to a downturn – the question is how deep. The next earnings season is going to be crucial because the forecast in the US is still relatively buoyant, which means there is room for disappointment. Certainly, companies are likely to keep guidance conservative. Expect continued volatility around earnings.
We therefore remain focused on quality businesses with resilient earnings, and companies that are likely to survive a recession and even come out on the other side gaining market share from weaker competitors.
Within fixed income, higher bond yields in 2022 have provided an attractive entry point for both government bonds – which should return to their role as a traditional risk off asset – and corporate bonds where one is now being paid sufficiently for both default and liquidity risk.
With such lack of clarity and visibility, it’s important to stay relatively neutral, balancing participating in any relief rally, as well as taking profits into that strength. We want to make sure we have liquidity to take advantage of future volatility.
2023 will be a challenge but we are close to the end of Fed tightening, probably past peak inflation and with more realism reflected in valuations (not bargain basement), there is room for cautious optimism. Our key is to participate in a recovery as our investors may not thank us if they miss out.
Alan Dobbie & Carl Stick, co-managers of the Rathbone Income Fund
We must look forward with confidence, because for all the bad news, there is the hope that things will slowly improve.
If the last three years have taught us anything, it is to never try to predict the future – portfolio construction must absorb this truism. This informs our flexible approach to portfolio construction.
The global economy faces considerable headwinds in 2023. The ongoing conflict in Ukraine and rising tensions in China represent a serious backdrop to economies slowing amidst aggressively tightening monetary conditions. Is this yet priced into global markets?
The FTSE 100 is dominated by global businesses, so we must recognise the impact of the increased likelihood of a global slowdown.
On the other hand, the UK market remains cheap. How much bad news is priced in? A brief period of relatively stable government combined with a budget seemingly inspired by economic rather than political expediency has steadied UK markets and strengthened sterling. We may hope that this continues into 2023.
The best UK businesses are managing to deal with supply chain issues, rising costs, and labour challenges, as evidenced by the latest round of corporate results. If they can maintain this momentum into next year, there is great value to be had. The UK market is rarely this cheap, and cyclical businesses, notwithstanding economic challenges are also good value versus defensives. We have been looking to selectively buy into both growth (tend to be niche ideas like Games Workshop, Experian, Dechra Pharmaceuticals, not just broad-brush approach to industry sectors) and cyclicality (cherry picking key industrials like Vesuvius and IMI). But the key is to look at each individual business and ask if they are positioned to deal with their own unique set of challenges and opportunities.
We must look forward with confidence, because for all the bad news, there is the hope that things will slowly improve. Each incremental piece of good news will highlight the value that abounds in the UK market. By paying the right price for any business, whether it offers growth or economic sensitivity, global exposure or domestic, there will always be opportunities.
