Columbia Threadneedle’s Anthony Willis has told investors to be prepared to take the opposite course of action to the consensus when it is pointing overwhelmingly in one direction – but he said the lack of certainty in markets means we aren’t at that point yet.
Willis was referring specifically to the dollar, which is at a 20-year high compared with most major developed market currencies.
Performance of currencies over 20yrs
Source: FE Analytics
Investors tend to gravitate towards the dollar in times of market stress due to its safe-haven qualities, and the currency has received a further boost this year with the Federal Reserve hiking rates more aggressively than most other major central banks.
However, Willis, an investment manager in Columbia Threadneedle’s multi-manager team, claimed the dollar’s strength may begin to wane towards the end of the year.
“We may well see the Federal Reserve ease back from its aggressive 75-basis-point hikes to something more like 50 or 25 basis points, and other central banks may start to catch up at the margins,” he said.
“The Fed has supercharged dollar strength, and that may start to reverse just at the point everyone becomes fully bullish on it.
“That will be the time to sell – when the consensus is all pointing one way, do the other thing. But we're not quite there yet.”
Although Willis said it is possible the dollar may surprise to the downside in the second half of the year, reducing one headwind, he warned the rate-hiking environment will continue to make life difficult for investors.
The Federal Reserve is trying to engineer a soft landing, which means hiking rates without causing a recession. This is difficult to achieve, with nine of the 12 hiking cycles in the US since the end of the Second World War leading to an economic downturn.
But even if the Fed avoids pushing the US into recession, Willis said it doesn’t necessarily mean investors will escape unscathed.
“The Fed raised rates quite aggressively in 1994, but the US actually saw a soft landing, so well done to the Fed,” he continued.
“But it did cause a huge bond crisis in Latin America and a political crisis in Mexico. It sowed the seeds of the Asian financial crisis in 1997, and indeed Russian defaults as well. So even when the US avoids a recession, a strong dollar and a hiking cycle often cause trouble somewhere else.”
Some bad news is already priced into markets, with the MSCI World index down 6.9% so far this year, and 14.7% if you exclude the impact of dollar strength. Growth has been hit even harder, with unprofitable ‘blue sky’ tech names down the most – many lockdown winners have seen falls of 80% to 90% from their peak.
Performance of index in 2022 (in local currencies)
Source: FE Analytics
Yet many fund managers have warned that the market could take another step down. While some retail investors are finding this difficult to envisage, Willis said they should think about the two components of a stock’s price-to-earnings ratio, and which one of these has yet to change so far this year.
“When we think about P/E ratios, we've seen the P has fallen significantly in this pullback as multiples have come down,” he explained.
“We haven't seen earnings expectations being revised lower. What we're hearing from a lot of companies is they are not seeing significant issues. Q2 corporate earnings season is just about under way now, but this is not necessarily the quarter where it all happens.
“But we are seeing more profit warnings at the margin and we are really watching out for those expectations to be revised down over time, maybe in the Q3 earnings season.”
Despite these headwinds, Willis said he is cautious rather than bearish, adding it is still possible to find opportunities in some parts of the market. For example, he pointed out you are now getting paid more for the risks you take with bonds, while from a regional perspective, Asia and emerging markets look better placed to cope with inflation than the West.
He also said it is important to remember the market and the economy are not the same thing.
“The market will most likely bottom well before the recession comes to an end,” he explained.
“Markets do not go up or down in a straight line. History shows that when markets trend lower, from time to time they get oversold. Sentiment and positioning are both very negative right now and a decent bounce is quite possible.”