Investec Investment Management’s award-winning World Axis range of funds are among the longest-running multi-manager solutions in South Africa, with over R250 billion in assets under management.
At a recent fund update, the World Axis team – led by Ryan Friedman head of multi-manager investments and lead fund manager, and fund manager Riaan Wagner – shared their outlook on the global macro-economic environment and tactical opportunities for investors.
US macro environment uncertain, with a recession likely over the next 12 months
“Our current focus is on preserving capital given elevated pricing of risk assets in the US, both in equities and credit. We believe a significant growth slowdown is looming for the US economy, possibly culminating in a recessionary outcome in the next 12 months, contrary to the soft-landing narrative that market pricing suggests,” says Friedman.
In January, expectations were that the US would see at least six rate cuts starting in March. The Federal Reserve, which has become increasingly data driven and therefore reactive to historical data, rather than setting forward-looking monetary policy, responded to elevated inflation with 11 rate increases between 2022 and 2023, bringing rates to 20-year highs.
Concentration risk
Today, however, investors expect just one or two cuts in 2024. Market pricing has diverged between bond and equity markets given a higher discount rate, with long dated bond yields selling off while equity markets continue to make new highs.
Given these divergences, the US Equity Risk Premium (ERP) is barley positive and the lowest in over 20 years. That means, investors demand no premium to hold equites over bonds, despite much higher historical volatility in the equity market. In addition, the S&P 500 dividends are offering the worst value compared to cash in 23 years, and despite this, equity holdings on household balance sheets have rarely been higher, driven, in part, by the market’s extreme optimism around artificial intelligence (AI).
There is substantial market concentration risk here: analysts have become increasingly bullish on Nvidia despite its parabolic rise. Buy recommendations for the stock have followed the share price of NVIDIA in an almost straight line.
The Magnificent Seven (Alphabet - Google, Apple, Amazon, Meta, Microsoft, Nvidia and Tesla), are up by 37% year to date, with the top five stocks accounting for 27% of the S&P 500.
Another way to show this is that over the past three months the top 10 stocks on the S&P 500 were up 17%, while the rest of the market was negative over the same period. The result is the worst market breadth for the S&P 500 in over 20 years.
We believe a significant growth slowdown is looming for the US economy, possibly culminating in a recessionary outcome in the next 12 months, contrary to the soft-landing narrative that market pricing suggests.
US consumers feel the pinch
Consumers, too, are probably under more pressure than investors realise. “We expect US consumers feel pressures towards the end of 2024 and into 2025 as pandemic-era household savings have now largely been depleted, and with the lagged effect of interest rates hikes, banks continue to constrict lending and delinquencies rise,” says Friedman.
From an income perspective, wages are under downward pressure due to a softening labour market. Unemployment is a mean reverting series and Friedman expects the labour market to continue loosening, potentially at a rapid rate as supply of labour begins to exceed demand.
In summary, cracks in the US economy are starting to show: savings have been depleted, wages are likely to continue to soften, lending standards are tightening and too many investors are chasing trends in AI stocks without paying attention.
Importantly, stock prices do not require a deep recession to experience a meaningful correction, the starting price for valuations is more important, and risk assets at the headline level are not cheap in the US.
“Some of our major asset allocation and investment manager changes that we've made this year, was in the global fixed income space. When bonds started selling off earlier this year, we increased our allocation to government bonds. In our Investec World Axis Flexible Fund, we switched a portion of our exposure back into the longer end of the US Treasury curve,” says Wagner.
“We started that process at a yield of 4.3% and then more recently upweighted it when the 30-year US Treasury was around the 4.8% level. So that carries a weight of close to 8 percent in the Investec World Axis Flexible fund. As we pointed out, we think that's quite an attractive hedge. As long-term investors, we are actually in a much better place today – higher yields tend to pave the way for higher long-term returns.”
As long-term investors, we are actually in a much better place today – higher yields tend to pave the way for higher long-term returns.
Japan offers significant opportunities for growth
“While Europe and emerging markets remain a point of interest for us, we have also seen significant opportunities in Japan, whose economy is reflating after decades of stagnation,” says Friedman.
There is general macro-optimism in Japan right now: the economy is growing with broad-based and sustainable inflation, and the latest Shunto wage agreement (the annual wage negation between enterprise unions and employers), saw the biggest nominal increase in 33 years.
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There are also significant efficiency enhancements in corporate Japan which are unlocking enormous value on company balance sheets – a move propelled by the Tokyo Stock Exchange (TSE) urging all listed companies to improve capital management.
“Allied to this, we are also very bullish on the yen, which has depreciated by around 80% against the dollar since 2012 and is nearly 50% undervalued on a purchasing power parity basis, making it the cheapest developed market currency in the world,” says Friedman.
The net speculative position on the yen is deeply negative and hedge funds and retail investors have consistently shorted it. That is because the yen has become a source of funds for the carry trade: people borrow in yen and invest in high-yielding assets outside Japan.
But if our expectations are correct that US yields will fall and growth will slow, then money will flow back into Japan as interest rate differentials converge.
“Japanese savers have $6.5 trillion (bigger than the Bank of Japan’s balance sheet) of savings invested outside their home country We do not need to see all this money come back into the country to see significant upward pressure on the yen,” says Friedman.
“We've upped our allocation to fixed income and introduced some defence in the portfolios, the likes of Japanese yen and gold bullion. So really utilising the full asset class spectrum to preserve capital and ultimately generate returns for our investors,” says Wagner.
Healthcare and global insurance have strong defensive properties and robust fundamentals
“Our view is that the healthcare sector will do very well over the next five years, breaking out from its recent underperformance,” says Friedman.
Finally, non-life insurance companies have seen very strong underwriting premiums in 2024 and we expect better book value growth for the companies than their historical rate of 10-11%. This could be as strong as 16% given the added benefit of higher yields earned on their float, “like healthcare, global insurance is defensive, with strong fundamentals and should protect well in a risk off environment,” says Friedman.
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