Look short, look long – is stock picking back for 2024?
Luke Newman, Portfolio Manager on the Absolute Return Equities team, argues how a normalisation of interest rates has prompted a significant change in stock dispersion, creating a better environment for stock pickers in 2024.
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- Markets have changed dramatically over the past 18 months, driven by a co-ordinated global shift in interest rate policy.
- Higher rates have led to a dramatic change in pricing, shifting the drivers of performance from large-scale macroeconomic factors, or geopolitical trends, to more stock-specific risks.
- This has created an environment that looks more suitable for active stock selection, where we see plenty of opportunities for absolute return investors, particularly (in our view) in areas like Europe and the UK, at both a sector and individual stock level.
What key factors do you expect to influence absolute return in 2024?
Changes in market structure don’t happen that regularly, but over the last year or 18 months, we have seen a dramatic change of course, prompted by the co-ordinated global interest rate cycle. This has led to a number of changes in economies and stock markets. But also, we have seen a dramatic increase in individual stock dispersion.
This should continue as we look forward into 2024 with an environment that suits active equity stock pickers and in particular absolute return long short funds that can take advantage of the opportunities on both the long and the short side of strategies.
Where do you expect to see the most compelling opportunities?
Opportunities are presenting themselves across every region and within every sector. And really the risk has moved back from macro factors to stock-specific risks. Notwithstanding that, though, we do see US consumer-facing equities still looking in aggregate overvalued, and we are still seeing some opportunities on the short side there. That has been a feature through 2023. Looking into 2024, our focus has moved slightly away from consumer stocks towards more industrial names, where we are seeing pressures on CapEx (capital expenditure) cycles, pressures on investment trends and excessive valuations.
So that will remain a focus on the short side. Away from that though, higher rates have led to a normalisation of the excessive valuation trends and practices we have seen over much of the last decade. And we are finding a lot of value on the long book in areas like Europe and the UK. Sector by sector and stock by stock.
What is the single most underappreciated risk?
I have mentioned how significant moving from a period of ultra-loose monetary policy to one of more normalized interest rates and financing costs is. But actually the after-effects can sometimes take a while to be felt, and that is equally from households and consumers who will begin to see more pressure on their loans of mortgages, but also in the corporate world. So whether it is interest costs and [the] costs of financing becoming more of a headwind, or pressures on investment and CapEx decisions, we will increasingly see businesses scrutinize their spending habits, given the pressures on a higher hurdle rate.
And of course, one company’s CapEx is another company’s revenue. So that headwind, which has not been meaningful for these periods of loose lower rates, becomes a bigger problem as we move forward.
What is the most important takeaway for an investor considering absolute return strategies in 2024?
From an asset allocation perspective, we can absolutely see the attractiveness of sovereign fixed income yields at these higher levels. But we strongly think there’s a part B to that argument. Normalizing the discount rates, normalizing the risk-free rate has created a huge improvement in terms of market structure, in terms of rational dispersion for individual equities. And this is creating a great opportunity for managers of absolute return strategies, long short strategies to capitalize and deliver consistent and attractively high levels of absolute return without having to take excess levels of risk.
Absolute return strategy: A type of investment strategy that seeks to generate a positive return over time, regardless of market conditions or the direction of financial markets, typically with a low level of volatility. A positive return is not guaranteed.
CapEx: Money invested to acquire or upgrade fixed assets such as buildings, machinery, equipment or vehicles in order to maintain or improve operations and foster future growth.
Dispersion: The range of returns for a security or group of securities.
Risk-free rate: The rate of return of an investment with, theoretically, zero risk. The benchmark for the risk-free rate varies between countries. In the US, for example, the yield on a three-month US Treasury bill (a short-term money market instrument) is often used.
Hurdle rate: The minimum rate of return a project or investment is required to achieve for the investment or project to go ahead.
Long position/long: A security that is bought with the intention of holding over a long period, in the expectation that it will rise in value.
Monetary policy: The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money. Monetary stimulus refers to a central bank increasing the supply of money and lowering borrowing costs. Monetary tightening refers to central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money.
Short position/short: Fund managers use this technique to borrow then sell what they believe are overvalued assets, with the intention of buying them back for less when the price falls. The position profits if the security falls in value. Within UCITS funds, derivatives can be used to simulate a short position.
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- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
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