Large caps over small caps
Since the stockmarket’s nadir in March 2009, smaller capitalisation stocks have considerably outperformed their larger counterparts over almost all geographies. Last year was particularly strong for smaller companies, the psychology of which seems to have been the return of investor confidence.
But by the start of 2014, our analysis led us to believe that this outperformance was becoming exaggerated, underscored by hedge fund managers’ extreme positioning and substantial fund flows.
We thought this momentum could fall victim to a sharp reversal and scaled back our position there, reinvesting the proceeds into funds with exposure to the less expensive and more defensive large caps. We started adding the Veritas Global Equity Income fund to a number of our multi-asset portfolios in January.
As the year unfolds, we believe the fund’s composition could provide some downside protection in more difficult market conditions, but could also offer upside if investors begin to look for opportunities.
Japan was last year’s strongest performer but has been the clear laggard among developed markets year-to-date as lacklustre economic data has dovetailed with fresh doubts about the effectiveness of Abenomics and fears over the recent rise in Japanese VAT.
We feel that data has been unhelpful but not damning. Although exports have suffered from a general deceleration in global growth, inflation is now at a 23-year high and the labour market appears to be tightening.
Japanese fundamentals are also much stronger than they were in 1997, when the last increase in the sales tax occurred. Prime Minister Abe and the Bank of Japan remain extraordinarily committed to enacting reforms and generating inflation. The past five months have seen a significant level of position clearing, with a substantial decline in the number of fund managers reporting they are overweight Japan – healthy signs in our view. Japan remains one of our conviction positions, with a key holding across our portfolios being the GLG Japan Core Alpha fund.
At first sight, market conditions appear relatively benign. We are now into a five-year equity bull market and credit markets are delivering steady rates of return. Central bank actions have been accommodative, underpinning prices as economic growth gains traction in the West.
Investor risk appetite is at or close to pre-financial crisis highs. But under the surface, many assets are below 2013 peaks, with many diversified multi-asset portfolios marking time over the past year.
We view market volatility at extremely low levels as being consistent with investor complacency. Substantial monetary and economic hurdles remain as central banks increasingly turn towards the exit and as emerging markets growth decelerates. Holding some dry powder in the form of cash could turn out to be the wisest investment in the near term.
Bill McQuaker is co-head of multi-asset at Henderson Global Investors