Nothing to fear but fear itself?

After braving Italian traffic, Head of Multi-Asset Investments David Coombs is in no mood to sit on the sidelines. But he worries that the fear-driven race to avoid missing the stock market’s few biggest winners could screech to a sudden halt.

By 20 July 2023

I’ve just spent a week on holiday in Italy. Stunning scenery, amazing architecture and incredible food. But crossing the road is probably more dangerous than throwing orange powder over Jonny Bairstow. The most foolish statement ever is: “Oh look, there’s a zebra crossing, let’s cross here”. Italian drivers accelerate into crossings like Max Verstappen accelerates into corners.

There’s nothing more frightening than choosing what you think is the safe option and it then turning out to be the riskiest. Take markets this year. The consensus view was that recessions were looming everywhere and strategists were recommending bonds and defensive equities as the safest way to navigate them.

How’s that feeling now? Like you’ve just been run over by a souped-up Fiat 500. Flat and embarrassed. Value traps everywhere and bond yields (which run in the opposite direction to their prices) driven higher by stickier inflation and no sign of lower interest rates.

To be fair, the playbook seemed to be pointing firmly in a defensive direction in late March and early April. I’ll be honest, we were pretty nervous at that point as we had very little exposure to gilts or defensive equities sectors such as consumer staples, utilities and pharma stocks. We had added to tech on weakness and felt like we were about to venture across a particularly perilous strada.

Then came AI hype, falling inflation in the US and waning fears of deep recession. Growth outperforms, quality cyclicals recover and bond yields peak. Savage rotation and we get to the other side of the road with a solid second quarter.

Getting away from the FOMO traffic

Big tech stocks are now looking very expensive again. But lots of investors missed out on them in Q2 and they’re in full-on FOMO mode. The momentum in tech is very strong, shorts are being closed rapidly and almost everyone seems to be expecting Goldilocks soft landings. I feel like I’m stuck on a crossing in the middle of an autostrada right now and I need to get off!

Trimming big tech feels right. I hear mutterings about running your winners… But in multi-asset land, you take the profits when you can and come back to fight another day. Experience tells me discipline is needed when it’s the performance chasers that are in the ascendancy. We now have decent exposure to 10 and 30-year gilts (and 10-year US treasuries) in case the soft landing scenario doesn’t play out, thanks to over-zealous central bankers. (Are you listening, Mr Bailey?)

And we’ve been buying S&P put options as the VIX volatility index has plummeted. We get nervous when volatility is low and the consensus believes recession will be avoided. If that consensus turns out to be wrong, and the recent guidance from chemicals companies (which we discuss in our latest episode of The Sharpe End podcast) – is right, then markets could be in for an unpleasant disappointment.

So, are we buying defensives? No – we raise liquidity and look to add to growth on weakness. We don’t need to be defensive in the equity portfolio: the beauty of multi-asset investing is that it gives us other levers to protect capital. The equities are there to drive returns and volatility helps us to accentuate them.

It’s always better to sell to those suffering from FOMO as opposed to joining them. We’ve just got to be patient. The older I get, the more patient I become - or is that slower? How about Eastbourne for next year’s holiday?

Tune in to The Sharpe End — a multi-asset investing podcast from Rathbones. You can listen here or wherever you get your podcasts. New episodes monthly.