Coop says 2022 was driven by two “generational events”, the first being the end of the low interest rates era when Russia invaded Ukraine, and the second being the end of the innovation bubble in investment markets.
But while he feels those are events of unusual significance in investment markets, he feels investors can learn lessons from recent history.
He said: “In the late 1990s you also had an innovation bubble and it was very hard for active fund managers to outperform if they refused to buy those bubble-type stocks. But for a few years after the collapse of that bubble, active managers did well.
“Then you had the commodities and financials bubble which ended with the global financial crisis. And during that period it was difficult for active fund managers to outperform against the market unless they owned those stocks. That cycle came to an end and active did well for a little while until the low interest rate and innovation bubble came along and led to the extreme mispricing of some assets, but now that has ended and there can be a period where active fund management does well again.
“The key is that when a fund manager’s bonus is linked to performance over the next 12 months, it is very easy for them to just buy the bubble stocks and that gives those stocks momentum, so its hard to not own them, until the momentum reverses.”
But while he feels active fund managers can thrive in the current environment, he believes the current very elevated level of geo-political uncertainty means the asset allocation component of active management could be more important than the individual fund or stock selection.
Konstantinos Venetis, senior economist at TS Lombard says the UK economy and market lagged the rest of the world for much of the 2010s, and so has more capacity to grow from here because it is coming from a lower base.
Although the FTSE 100 actually delivered a positive return in 2022 and hit an all time high at the start of 2023, UK equities remains stoutly out of favour with investors. The latest data from the Investment Association shows investors pulled £1.4bn from UK equity funds during January, month in which there were inflows into US and Asian equity funds.
Rupert Thompson, chief economist at Kingswood, says there was plenty of room for debate around the appropriate description of the US economy right now but he said: “There is no need for any new-fangled terminology to describe the outlook for the UK, with stagflation looking a pretty accurate description. On the growth front, retail sales surprised on the upside in January, rising 0.5 per cent and reversing some of their decline in December.
“With the squeeze on real incomes beginning now to moderate, a period of stagnation or mild recession now seems on the cards for the UK over the coming year, rather than the more severe downturn feared a few months ago.”
Stagflation describes a period where an economy has an inflation rate which is much higher than the target rate, but economic growth which is negative or very low.
Central banks can put interest rates up in an attempt to drive the inflation down, but that would also be expected to reduce the GDP growth rate, or they could cut interest rates to stimulate economic growth, but that would be expected to add to the inflation.
One of the reasons the UK underperformed relative to other markets during that period was the fact the FTSE has fewer of what Coop calls the “innovation bubble” stocks.
Alex Wright, who has run the £3bn Special Situations fund at Fidelity since 2014, is another investor who believes 2022 marked the end of a bubble in certain types of stocks. He places the end of the bubble as occurring as interest rates rise, and they rose as a consequence, to a large extent, of the commodity price inflation caused by Russia’s invasion.
He says: “2022 was a year when a lot of overvalued assets did poorly. I think its important for investors to remember though, that rates have risen to the sort of level that is normal is relative to history, the rising rates environment of 2022 is not the outlier, it is the decade prior to that which is the outlier.”
And he says it is no coincidence that this return to what he considers a normal interest rate environment “also marked the first year in six in which UK equities outperformed relative to the global market”.
Wright says that in more normal market conditions, the challenge faced by investors in growth and innovation type stocks is that they “have to get a lot of them right to make up for the ones that fail. But in the years up to 2022, that was suspended as all of those types of stocks went up. But again, that is not the normal market condition, that is the outlier”.
Wright’s fund is currently the fifth largest UK equity fund available to UK advisers and their clients.
His response to the current market conditions is to buy more of the stocks that benefit from a long-term higher interest rate environment, such as banks.
Perhaps unsurprisingly, Nick Train, who runs the £1.8bn Finsbury Growth and Income investment trust and pursues an investment style which tends to do better when interest rates are lower, has a slightly different view to that of Wright.
He says many of the largest stocks on the UK market, such as Burberry, are sensitive to the outlook for global economic growth, rather than the UK outlook, but have suffered for being listed on the UK market when the latter was out of favour.
His view is that as sentiment towards the UK stock market improves, so the share price performance of the globally focused companies can also improve.
Further down the market cap scale, George Esnor, a UK small cap fund manager at River and Mercantile, says the challenge with investing in the AIM market right now is that companies which are eligible inheritance tax relief trade at very high valuations, but are also the most liquid, while those which are not eligible for that, are less liquid.
For that reason, he is currently focused on the smaller company segment of the main UK market.
