Hunker down or venture forth? Or can you do both?

Life is like riding a bicycle. To keep your balance, you must keep moving.

Albert Einstein

In the space of a few weeks, we moved from the doldrums of 2022 – the worst year for equities and bonds since 1927 – to the kind of market bounce back that could give the unsuspecting investor a severe case of whiplash. Today, markets are largely caught somewhere between the two, suggesting that investors simply can’t decide how this strange and difficult year is likely to pan out. All of this begs the question; how should long-term investors really feel in this environment? Should they be pulling up the metaphorical drawbridge ahead of further market troubles, or striding into the fray to capture opportunities at distressed levels? There is of course no simple answer, but the good news is this; family investors, with the time, capital and liquidity to make interesting investment decisions, are amongst the best placed in the marketplace to navigate these difficult times. Here, we set out our thinking for the year ahead, and the ways that we’re shaping family capital accordingly.

The case for caution

Markets, investors will tell you, love certainty. There’s no arguing with that fact, but there might be something that they love even more, and that’s liquidity. The world economy shut down almost overnight when the pandemic hit, but the subsequent tidal wave of liquidity unleashed by central banks flushed out any fears around the future. The market rally we saw in January – on the back of dollar weakness and peaking inflation - was really a mini version of that same liquidity-driven bubble. We don’t even need to look deeply at the fundamentals to come to that conclusion, we just have to remind ourselves that the recessions in key economies haven’t even started to bite yet. So from this perspective, our view is clear; this environment warrants caution. We’re perfectly likely to see more liquidity-driven rallies over the coming year as inflation cools, but we would rather tap into them through equity options strategies than take on too much direct equity risk, given the oncoming hit to corporate profit margins.

In the simplest terms, this is a risky economic environment.

Cautiously opportunistic

In the simplest terms, this is a risky economic environment. But, unlike our earlier analogy of embattled investors pulling up the proverbial drawbridge, we don’t have to be quite so black and white when it comes to risk taking. This is certainly a time in which to have protections in place, but it’s also important to be able to capture the kind of long-term investment opportunities created by these seismic market distortions. So where are those opportunities today? Starting broad; value equities are still incredibly cheap compared to growth equities, and that’s despite the battering taken by tech and growth stocks in 2022. That, combined with US dollar weakness, suggests to us that value equities, particularly those outside of the US, still look attractive. Delving into specifics; Japan looks interesting. It has a good showing of companies trading at low valuations but with strong balance sheets; the yen is still cheap relative to the dollar, corporate reform is well underway and Japanese corporate profitability has been almost as good as the US. Add the return of inflation into that mix, and you have a very interesting opportunity set indeed.

Keeping active

The one critical factor in balancing caution and opportunism in portfolio construction today, is active management. We are firm in our view that the days of being able to allocate passively and let markets rise on the back of ultra-low monetary policy are behind us. We manage risk with a highly active approach, and we expect the same of the managers with whom we allocate capital. In volatile times, the right active managers can snap up opportunities when markets decline while avoiding sectors and companies that are more vulnerable to longer term headwinds. The same goes for bonds – an asset class that we have largely avoided for the past few years, but which is starting to look more attractive. As we move out of a world of cheap debt and into one with structurally higher rates, we’re likely to see dislocation in credit markets and potentially a rise in the distressed cycle, leaving more room for active managers to pick up assets at attractive prices. Looking at credit in general, spreads are not yet pricing in the full risk of recession; so the right managers will be in the position to capture market as well as stock picking opportunities.

The environment we’re in now requires a much more nuanced approach to capital allocation.

Bracing for change

We have undoubtedly now moved into a very different investment environment from that which most investors today are used to. Blended 60/40 equity/bond portfolios were, for a long (albeit exceptional) time an easy way to build portfolios, and passive equities were an easy way to make money. We think that has now fundamentally changed. The environment we’re in now requires a much more nuanced approach to capital allocation. It’s not all bad news, there will be opportunities, but only those who can protect capital during market lows will be in the position to capture them. That’s exactly why we’re bracing portfolios for difficult times ahead, while keeping a weather eye on the kind of opportunities that can meaningfully compound capital for our clients.

All information and opinions expressed are subject to change without notice. Advice is given and services are supplied by Capital Generation Partners LLP and its affiliates (“CapGen”) on the basis of our terms and conditions of business, which are available upon request. No liability is accepted or responsibility assumed in respect of persons who are not clients of CapGen, unless expressly agreed in writing.

This does not constitute investment advice or an offer, contract or other solicitation to purchase any assets or investment solutions or a recommendation to buy or sell any particular asset, security, strategy or investment product.