UK equities
04 Dec 2018

Preparing for a soft landing

Expect the Fed to follow the data and take the slower path to rate increases, while in Britain there are plenty of opportunities for investors to consider, says Richard Buxton.

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The wild ride in asset prices at the start of the fourth quarter may have left some investors fearing the worst and wondering about the direction of financial markets.

Treasury yields surged and stock markets around the globe sold off dramatically. October was the worst month in six years for global stocks. The impact of central bank unwinding, slowdowns in China and emerging markets along with trade war ructions signalled, for some commentators, the end of the long bull run in equities.

I don’t agree. A little fear isn’t a bad thing. October brought a healthy shakeout in equity markets and a breaking of some momentum trades. It may also have helped us on our way to a better place.

To be sure, the US Federal Reserve (Fed) won’t back down immediately, but it will follow the data and we expect this to show a weakening in interest-rate sensitive industries such as housing and autos. Indeed, this has already begun.

As the impact of higher rates on these industries becomes more pronounced, we believe the Fed will begin to alter its rhetoric. The language associated with a move in March is likely to be more dovish.

We expect financial markets, which have been sceptical of the Fed’s plan for four rate hikes in 2019, will sigh with relief and embrace a moderation in economic growth – albeit with some volatility for risk assets. This should be seen as “the pause that refreshes” the US economy and steers it clear of a recession in 2020 that is forecast by many economists.

There’s no sign of a Treasury yield-curve inversion that would signal a recession, nor are there big worries in investment-grade or high-yield corporate bond spreads.

One caveat to this scenario is that inflation is kept in check, which we expect to remain the case.

Closer to home, we see opportunities in the UK that the international fund management industry seems to shy away from because they are concerned about Brexit. British companies are in pretty good shape. They are trading on around 14 times earnings, near the 40-year average, so not expensive. I expect the UK economy is going to gently accelerate into 2019. There is a very strong labour market, and the chancellor is prepared to increase public spending.

We’re not the only ones who see good value. Overseas corporations continue to buy UK companies or parts of them, as we saw with Coca-Cola buying Whitbread’s coffee business.

There’s potential for a change in leadership in the market as interest rates gradually move upwards,  led by the US but I expect the Bank of England to do more next year also. Rising interest rates and higher volatility are good for banks, so they may become more in favour, while growth stocks, tobacco and consumer staples, may begin to come under pressure. We also see interesting self-help and turnaround situations, when new management comes in to improve companies, like at Tesco.

There will be patches of turbulence here and in the US but we’re preparing for a soft landing. While we’re constantly reviewing our holdings, we’re absolutely comfortable that our portfolio of well-managed companies, trading with attractive valuations and offering consistent returns, is the right one.

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