Written by Kelly Prior, Investment Manager, Columbia Threadneedle Investments Multi-Manager team
Four sectors that could sparkle as the days get darker!
It’s been a mighty long year, with markets and the weather being perhaps not what was expected, particularly in recent weeks.
But Q4 2023 and darker days are now with us. Seasons like markets change and, with Bonfire Night rapidly approaching, I wanted to highlight four sectors that could sparkle in 2024, alongside funds that we currently hold in our portfolios that target opportunities in those sectors!
European small caps – A skyrocket waiting to take off?
Europe has just not been sexy enough in the last few years to be worth garnering the attention of the majority of the investing community. For one, it makes up a less than punchy weight in the global equity market indices with the heavyweights of France, Germany and Switzerland making up less than 8% of the MSCI AC World Index – with half the combined index being made up of financials, health care and industrials (yawn) no wonder. So, Europe is, in the eyes of the global investor, pretty insignificant.
If we then narrow this universe down further and look at small caps – the MSCI Europe Small Cap Index is just 14% of the free float-adjusted market capitalization of the European equity universe. In the context of the MSCI World Small Cap Index just 8% of the index is made up of Sweden, Germany, Switzerland, France and Italy – so again pretty insignificant if you are a small cap investor. Yet even within this peer group, European smaller companies are cheaper and pay a higher dividend.
If we think about the rotation of markets and the dawning of new themes as the investing environment changes, we know that organic growth is going to be harder to come by. Active managers are as excited as I have ever seen them about the potential for mispriced opportunities down the cap spectrum. These companies are, quite simply, off the radar for passive and price insensitive buyers who will suffer the reverse effects of the recent trends if momentum turns and CTA models follow. Dale Robertson and Gareth Rudd are leaning into this space with their multi cap Chelverton European Select fund buying companies with better cash flow, better sales growth and virtually no debt compared to the broader European market – the anticipation of the first of many fireworks is building in this space for sure.
US – leave the toffee Apples for someone else?
The dominance of the US in global markets, in both return and weighting terms, is not new news but I find it hard to not include this in this article as it really could be the big bang for world markets at some point soon. US equities make up just shy of 62% of the MSCI World Index, and within this nearly 5% is just one company (Apple, of course). This ranks Apple as a single company as the third biggest weight in the MSCI Index, behind the US and Japan, whose weight is 5.5%. If you buy a
passive world exposure you are making an active call to buy the US market (not the US economy by the way which is an entirely different thing) and within that one stock. My esteemed colleague, Adam Norris, wrote a brilliant piece on this (‘’Avoiding the Scrum’) which details how we have got ourselves into this situation/ In brief, each decade has been dominated in some way by a super theme and the Internet and Tech have been in play now for two of the last six decades. Change does happen and, when it does, it can be brutal. Ask anyone invested in Japan in the late 1980’s. Scott Molinaroli and the team running the Snyder US Concentrated All Cap fund have suffered through their lack of exposure to the ‘Magnificent 7’ mega cap stocks, despite having positive earnings for all but one of their stocks, strong free cash flow and a heavy emphasis on balance sheet strength. They have the potential to sparkle in a broader market, even if economic conditions get tough given the quality of company that they lean into.
Japan – the (Catherine) wheels are starting to turn…
Ah 1989. The year of the fall of the Berlin wall, the Galileo Spacecraft being launched by NASA, the release of the Nintendo GameBoy and the last time Japan’s equities represented nearly half of the MSCI World Index. How the mighty have fallen with Japan now less than 6% of the same series. The years that followed the 1980’s saw Japanese companies feel the pain of their excesses as they entered the “lost decade (s)” where the naturally introverted Japanese allowed their companies to become social enterprises at the cost of equity owners returns. Three decades on, and for the sake of the ever-aging population who now need to see a return on their one time earned savings, the authorities have taken matters into their own hands and are pushing the buttons of social conscience. Being made to explain why you are not making a return on your capital is not something any self-respecting (and the Japanese are all about self-respect) CEO wants to do.
At the headline level the Japanese market is not necessarily the place to invest. A bit like the conundrum of sustainable investing, the ugly could be getting a “glow up” (ask a teenager) so on the face of it are set fair to benefit as many have year to date, but it is in the nitty gritty away from these complex beasts that the real gems are to be found. By way of example the Morant Wright Japan Nippon fund has a portfolio with a price to book ratio of 0.78x and (ex-financials) net cash and investments worth 59% of the market cap of their stock prices across the portfolio. Japan has failed may times to address the issues created in the glorious 80’s, and for this reason many ask why bother? They have form many times over of missing an opportunity, but performance this year may yet turn a few absent heads to turn a few undisturbed rocks. Trying to time whether Apple is going to exceed expectations, let alone know how the market is going to react to it, feels like a lot less comfortable place to be than buying a cheap unloved market that has the wind and fundamentals in its favour for the true long-term investor. As an aside, 1989 was also the year of the Savings and Loan crisis in the US where nearly a quarter of all US savings and loan associations required bailout due to poor real estate lending practices and an easing of regulatory oversight. Ring any bells?
UK – Stay closer to home for the big bang?
Being a UK fund manager has been a tough gig in recent years with cool Britannia being superseded by Brexit, ‘Trussanomics’ and, more latterly, an inflation habit that is hard to kick. Reflecting this a recent missive by Jamie Seaton and them running the GVQ UK focus fund highlight just how cheap the UK is relative to both its own history, but also that of its global peers. If we extend this further,
they point out that UK mid-caps have NEVER been as attractive as they are currently relative to their large cap cousins.
It is always hard to not to be tempted by the flashy displays, but in investment seeking out something a bit different is where the rewards are to be found for the long term. The UK economy has surprised to the upside relative to battered expectations with the IMF dramatically upgrading its economic forecasts, while corporate profits are increasing faster then in most other countries. Corporates return on equity has risen while their price to earnings has fallen – the reverse of the Dow Jones. And then there are the dividends – compounding is the 8th wonder of the world according to Einstein, and reinvesting the income that UK companies are renowned for achieves just that. In short, the UK market is unloved, under-owned and yet has solid fundamentals and an economy that should put on a good show from here.
This is a marketing communication and does not constitute investment advice or a recommendation to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. Views are held at the time of preparation.
