Going into 2023, most investors were braced for further market falls. Sticky inflation, central bank tightening, geopolitical uncertainty and the spectre of recession seemed to indicate further volatility on the cards.
Few would have predicted a powerful rally that has seen the S&P 500 up about 18% through August. But for how much longer can this theme continue to buoy up the market?
Going into Q4, investors are faced with the difficult task of trying to make sense of an uncertain macro picture, while making tough calls on themes in markets that might or might not be alpha generators going forward. So where are investors positioned now- and where do they hope to generate returns?
Rupert Thompson, chief economist at wealth managers Kingswood
‘Enduring sources of alpha are scarce. The overall uncertainty of the macro position is creating choppy markets in which it is very easy to be whipsawed,’ says Rupert Thompson, chief economist at Kingswood.
‘Looking forwards, Thompson sees the possibility of recession still on the cards, despite seemingly bullish indicators such as the Atlanta Fed’s Q3 real GDP growth estimate of 5.6%.
Note: The top (bottom) 10 average forecast is an average of the highest (lowest) 10 forecasts in the Blue Chip survey
The firm’s big call at the moment is underweight the US, overweight the UK and emerging markets- largely based on valuations.
‘We are largely neutral at a sector level, but with valuations so high especially in the US we see risks to the downside over the next six to 12 months. As a result we are keeping a defensive tilt over the rest of the year.
‘At some point we will see rate cuts coming through, and that will be the time to move more into interest rate sensitive sectors,’ he says.
Peter Garnry, head of equity strategy at Denmark’s Saxo Bank
Peter Garnry, head of equity strategy at Denmark’s Saxo Bank, is wary of the risks to the US market in particular. ‘We’ve reached a multi-decade negative valuation gap when it comes to the US versus Europe,’ he points out.
He is also worried about the concentration risk created by the outperformance of a narrow group of mega caps, given that the magnificent seven have been responsible for such a high proportion of the market’s gains this year, even after a late-August retreat.
‘At this point we are negative on tech on a valuations basis, and overweight defensives such as energy, healthcare and consumer staples,’ Garnry notes.
Looking at longer-term alpha sources, Garnry notes that semi-conductors, despite the recent price runup, offer a secular growth play on ongoing global digitalisation.
‘Other broad themes for us include a renaissance in nuclear power as an energy source, as a part of the transition away from fossil fuels,’ he says.
Over the very long term he sees biotech as very important. ‘Much of the runup in AI stocks has been premised on the productivity gains the technology is likely to deliver. We think advances in healthcare could also deliver enormous gains.
A drug such as Eli Lilly’s tirzepatide, which in tests has shown a significant ability to combat obesity, could be a game changer in this respect,’ he says.
Thomas McGarrity, RBC Wealth Management
Against this fast-moving economic backdrop, it’s important to be flexible and open-minded, Thomas McGarrity, head of equities at RBC Wealth Management, stresses.
‘The US has been strong year to date, led by AI and big tech, as well as cyclical rallies driven by improving data points, although the latter can reverse quite quickly,’ he notes.
The question for many investors now is whether they should be looking more to cyclicals or defensives. ‘If the benign macro environment persists then there is catch-up potential for sectors such as energy, which has been a laggard this year.
But on the other hand, if we see a deteriorating economic outlook as the effect of rate rises feeds through into the economy, that could see a resurgence of defensive areas such as healthcare and consumer staples, which have mostly underperformed this year.’
This year’s focus on AI, McGarrity believes, has still seen investors overlooking some companies that are potential downstream beneficiaries of the trend, for example those in information services.
‘Companies with strong data analytics should be able to integrate generative AI into their products, given their embedded relationships with clients. We think there are still some overlooked opportunities in this area,’ he says.
