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Bill McQuaker: Finding pockets of value late in the cycle

McQuaker-Bill-700x450.jpgInvesting at this stage of the market cycle is a tough balancing act. While over-exposure to risky assets leaves a portfolio vulnerable when a correction really bites, taking too much risk off the table too soon can mean missing out on the remaining opportunities which may still present themselves over the coming months.

With so many reasons to be cautious at the moment, finding attractive opportunities on a risk-adjusted basis requires looking across asset classes and sectors. I’ve been thinking recently about a handful of “special situations”, which I think have the potential to deliver strong performance over the coming months, having been largely left behind during the bull run we have seen over recent years.

Two of these are in equity sectors – US utilities and European telecoms – both of which remain relatively unloved as investors have moved towards other (and arguably sexier) areas of the market. But over the coming months, as global investors must deal with an increasing amount of uncertainty, I think the case for these less cyclical equity sectors is becoming ever clearer.

Fund managers line up new value statements for clients

Whether it is political jostling in Europe, changing monetary policy, rising oil prices or the continued nervousness around US foreign and trade policy, there will likely be no shortage of triggers for volatility over the rest of 2018, and it makes sense to look towards these more defensive areas of the stock market.

In Europe, telecoms stocks have largely avoided the limelight in recent years, struggling to keep pace with more cyclical sectors like technology. Indeed, stock prices in European telecoms have fallen around 30 per cent since their peak in 2015, while tech names have gone up around 60 per cent over the same period, according to Bloomberg. But aside from valuations, I think this sector has potential for a turnaround as it emerges from a particularly difficult period of regulatory change.

In recent years, many of the industry’s well-established cash cows (for example, roaming charges) have been largely clamped down upon, forcing telecom companies to invest and recalibrate their business models to move forward. I see some evidence to suggest that these companies have now passed the point of maximum spending, which could mean that free cash flows begin to look stronger.

What next for multi-asset?

US utilities are another relatively defensive area of the market, which again have lagged behind other sectors during the current bull run. In absolute terms, performance hasn’t been too bad – but looking at the sector’s performance versus the broader S&P 500 tells a different tale. These companies have underperformed other US equity sectors by a considerable margin, but it is worth remembering that the prospects for an area like utilities will depend significantly on the broader US growth story.

These stocks offer relatively consistent and predictable cash flows, meaning that their performance is closely linked to 10-year US Treasury yields. Normally, a rise in the 10-year yield would suggest a positive or accelerating growth backdrop for the US, and this has posed a challenge for the sector as a whole. For investors, the key question going forward is about whether US growth can continue to be resilient over the coming months. If so, utilities are likely to keep struggling. However, I think it is likely that the US will slow down over the course of this year, which would be supportive of the sector relative to others.

For multi-asset investors, it is worth repeating that the remainder of 2018 is likely to be a tricky balancing act. It is important to make portfolios robust, but this does not simply mean allocating to low-risk asset classes like government bonds or cash. Indeed, this approach carries its own risk of missing out on growth opportunities that remain in markets.

More from Bill McQuaker

Instead, making a portfolio truly robust as the cycle continues to mature will involve looking for specific opportunities in higher-risk areas like equities, and finding those which stand to benefit from the corrections we are likely to see over the rest of the year.

European telecoms and US utilities are two examples of these ‘special situations’, which we’ve recently added to funds in the Fidelity Multi-Asset Open range. We look for asymmetrical opportunities with prospects that are skewed to the upside, and I think these two sectors could deliver as markets face increasing uncertainty over the rest of the year.

Bill McQuaker, multi-asset portfolio manager, Fidelity Multi-Asset Open funds

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