Thank you for joining us for the Market GPS Investment Outlook 2024 webcast, hosted by Janus Henderson Investors. We are pleased to offer you simultaneous translations today in French, Italian, Spanish or German. Please click on the translation tab at the bottom of the screen to listen in. Please also submit any questions in the Q&A box in the platform.

I’ll now turn it over to our moderator, Matthew Bullock, AMEA Head of Portfolio Construction and Strategy, to begin the webcast.

Matthew Bullock (MB): Hello, and welcome to our Market GPS 2024 Investment Outlook webcast. By way of quick introduction, my name is Matthew Bullock. I’m the EMEA Head of Portfolio Construction and Strategy here at Janus Henderson Investors. My team’s role is to work with clients all across the world, to discuss what’s happening in the markets, help make sense of what’s happening in the markets, but most importantly, what are the implications for portfolio construction? That’s why I’m so pleased to be hosting the 2024 outlook, which I know is going to be a really fascinating conversation.

Looking to the New Year, we believe investors will face a complicated series of chain reactions, with the convergence of forces including inflation, a higher cost of capital, failing consumer strength and geopolitics. So, today, we’re going to explore a number of those things. We’re going to talk about the areas of the market that we believe will struggle and which ones we believe could also benefit. We’re also going to talk about what our investors are looking out for in 2024. Then finally, we’ll touch on any longer-term themes to participate in.

So, to help me answer these questions and many more, I’m delighted to be joined today by three experts from across the investment teams. Starting on my left, Luke Newman, Absolute Return Portfolio Manager, Kareena Moledina, Fixed Income Client Portfolio Manager Lead for EMEA, then finally, Richard Clode, Technology Equities Portfolio Manager. So, welcome, all three of you.

So, Karina, to start things off, so inflation and rates were clearly front of mind for investors in 2023 and there’s lots of debate about the future direction of central banks and whether they’ve done enough or potentially gone too far to control inflation. So, how does the Fixed Income Team see 2024 evolving?

Kareena Moledina (KM): Yes, sure. I guess the first thing is, we’re all talking about how it’s the year of the pivot and that’s really important. Central banks have got the upper hand now, in terms of managing inflation, and are able to focus now on rate hikes in 2024. Now, when you look at the consensus inflation forecasts, they’re showing that undeveloped markets, you’re just below 3% in 2024. Those are the expectations that we’re seeing. Why is this important for fixed income? When you look at the relationship between fixed income and equities, you’ve seen that there has generally been a positive relationship over the last 12 months.

So, everyone’s saying, my fixed income portfolio is not behaving like it’s supposed to, and what’s happening here? If you look at the correlations between the S&P and US 10-year [government bonds] over three years, you can see that there is a positive correlation when inflation is greater than 3%. So, if you believe those consensus forecasts that we’re going to go back to an environment that’s below 3% in developed markets, then you would expect that relationship, that negatively correlated relationship between bonds and equities, to come back into play. So, that’s quite exciting for us in fixed income and hopefully provides some respite for everyone that’s wondering what’s happening with the ballast in their portfolio.

The other point… When we look at rate cuts and the focus there, the market is pricing in at around 100 basis points of cuts from the US Federal Reserve next year, and also looking forward, pricing in… I think most of the economists out there are saying that’s going to happen in the second half of 2024. So, really, we’re hearing 25 basis points in rate cuts per meeting. That means to around mid-2025, you’re going to get to sort of 3.5% in the 10-year in the US.

So, all of this is going on. There’s going to be some interest rate volatility, but going back to fixed income and why it’s important for the fixed income, well, it’s the higher rates that have led to us having higher yields and attractive yields in the fixed income market. Like, equity type yields. I think the entry point is very attractive from an income perspective. So, if you’re going to see interest rate volatility, if you’re going to see a weaker economic backdrop, you’re still going to have some cushion from that income that you’re getting from yields, given where we are.

MB: So, before I go to the equity side, you mentioned before about potential cuts. How much do you think the market is pricing in already? Does that change, or will that change your outlook for next year?

KM: Yes, it’s quite… When you talk to everyone out there who are doing the surveys… People are looking at this 24/7. Everyone has got a completely different view in terms of the size, the magnitude, and people are saying, the economists are generally saying between 100 to 175 basis points, I would say, out there for next year [2024]. But it’s going to be an interesting road to get there. I think obviously that could change. If we do see a weaker backdrop that could happen quicker. So, there are all these catalysts that still have to be navigated through the market.

MB: Got it. Then, yes, we talk about the equity side of things, but thinking about this year, the year has ended up quite positive for equities but it really hasn’t felt like that for a lot of the course of the year anyway.

Luke Newman (LN): No, and I think that’s probably a function of the large falls that you saw in the equity market in 2022 for most indices. We’ve seen a bit of recovery there. Maybe a bit more resilience in economies. Plus, the speculation around the peak or end of the rate cycle.

I have to say, aside from direction, I think the biggest shift this year has almost been in terms of what I want to call, market structure, and I want to say as an active stock-picker, what we’ve seen is a real return to more normal equity markets. Higher discount rates, higher interest rates, and I think you can make a case that we’re not going back to the ultra-loose monetary policy that we saw for most of the preceding decade. It really transforms the picture within equities. We’ve seen, yes, lots of volatility, but it has been rational. So, we’ve been presented with rational dispersion and it has really allowed bottom-up fundamental stock picking strategies, and really active management to return to where it was looking back the best part of a decade.

So, a real advantage for active management and, I would say, as an extension, a real boon for equity long-short, because there’s rationality on both the long and the short side of the portfolios.

MB: How does that dispersion fit in with the narrative of the Magnificent Seven?

LN: Yes, it’s a great question. I would say there has clearly been a big skew, given the size of those larger tech businesses within the US. If you look beyond them, actually we’re seeing the same sort of dispersion that’s more evident in Europe, in the US. Clearly within the UK and Europe, it’s very evident.

We’re seeing valuations reestablish themselves back to a world where the discount rates for interest rates were in this 3% to 5% range. So, more normal, and it’s not all good news, because normalised cost of financing actually is a headwind. It’s a headwind for consumers. We’re all aware of that personally and professionally, but actually it’s an increasing headwind for more indebted businesses. But I would argue again that those difficult decisions are rational. Again, if I’ve got a short side of an equity long-short portfolio, that could present some opportunities.

MB: I should’ve addressed the Magnificent Seven question to our tech portfolio manager over there. Anything to add?

Richard Clode (RC): Yes, I think when you look at the Magnificent Seven, it’s a very nice way of bucketing together a group of stocks that have performed very well. But to Luke’s point, there are many names that have performed well outside of that, and I very much would echo Luke’s point about the fact that we’re going back to fundamentals. We’re going back to a market that rewards unexpected earnings growth and vice versa. So, positive and negative.

For us as bottom-up stock pickers, that’s a great dispersion to be able to actually take advantage of, which is very different to the market environment over not just the last ten years, but probably going back to the Global Financial Crisis.

MB: So, I know you spent a lot of time looking longer-term to address what are some of the key themes coming out of the market and then trying to position portfolios for that. So, could you just touch on how you’re feeling about thematic investing in this type of environment, in particular around the situation where rates potentially could be a headwind for some of those sectors?

RC: Well, as we just heard, the macro environment into next year is a bit of a mirror into some of the uncertainty we were looking at in the macro environment into this year. But I think against a backdrop of consensuses of a ‘higher for longer’ [interest rate] environment, what does that mean? That’s a lower growth world and in a lower growth world, I think thematic thinking and investing is a great lens to try and identify some growth in a world that’s pretty devoid of it.

So, whether you’re looking at it from a technology and innovation point of view, from the innovation we’re seeing in healthcare from both AI and obesity drugs, GLP-1s to sustainability, and still many of the goals we need to hit on the environmental and the social side, or whether we’ve got to reimagine from that point of view our cities from a property point of view, there are great growth opportunities out there.

But to the point made around the return of the cost to capital, a lot more emphasis on the word, investing, in thematic investing, and not just buying a stock because it has got something to do with one of those themes. But actually a stock that’s going to deliver outsized profit growth from those themes, and then be rewarded sustainably as a stock for that. That’s what’s very different to what we’ve seen in recent years.

LN: I think that’s a great point actually. We’ve emerged from this era within the equity world of growth at any price being rewarded. Actually, that was frustrating for a number of investors, but we had to learn to live with it. Actually, what we’ve seen for the last year is actually an environment where again it’s rational volatility, and actually the importance of valuation, because we now have a discount rate which is non-zero and non-negative, actually it feels like it matters a lot more.

MB: What about fixed income? So, how are you thinking about some of the key areas of the market looking forward?

KM: Yes, if I look at most of the allocations that I feel like clients have been making, it’s gone into money markets at the moment. I think that trend will start to move from money markets into fixed income. If you feel like the Fed is at peak rates and history has shown that when we’ve been here before, that you’re going to see higher total returns for duration-focus assets over money markets. So, I think we’ll start to see a shift.

So, we do lack duration at this juncture and then looking specifically at areas within fixed income, and a lot of it’s looking quite attractive because of the yields that we have, we’re still concerned about some of the uncertainties in terms of the macro backdrop. Everyone’s talking about, is it a mild recession, is it a technical recession, is it no recession? We don’t know. We can’t predict that, so we just want to be able to navigate that and we think that is about having a diversified credit portfolio as well.

So, when we think about that, we like corporates but we prefer to be in investment growth versus high yield, where we do feel like there will be a pick-up in defaults. We feel like you can manage that risk better in investment grade, given the actual yields that you’re getting. But also, we think it’s important to diversify your corporate credit return with some securitised exposure, and also agency MBS. They’re two areas that we really like. So, if you think about your corporate credit exposure, that’s your business and financial risk, and then when you’re looking at your securitised exposure, you’re actually diversifying with a different risk profile because you’re talking about the risk of the impact on the consumer and the underlying loans within your calls.

These are really, to be clear, very high-quality asset classes, low volatility. So, we like the idea that you’re getting a good spread pick-up. The valuations look attractive, because if you look at the 10-year valuations of the securitised market relative to where it is now, relative to where it is on a 10-year average, and then you look at the same story with corporates, the spreads look very expensive on the corporate side. So, we feel like here you’re getting the yields on the corporate side. That’s attractive, in corporate credit. But we feel like the valuations in the asset-backed securities market, [and] in the agency MBS market, is very attractive for what is a very high-quality asset class.

MB: So, there are two things I wanted to just ask you a little bit more about. First with the high yield side of things. Are you avoiding high yields altogether?

KM: No, not at all. I think this is where we come back to the whole point about dispersion. It’s an exciting time for us, similar to what Luke and Richard have said, in the sense that you’ve had these zombie companies that have just been kept afloat and now you’re starting to see cracks. We saw that in March 2023, where we had the bad banks fail and the good banks benefit from what happened. I think you’re going to start to see that come out.

So, there are certain sectors where we’re starting to see negative earnings; chemicals is an example, but it’s not all companies within the sector. So, it really will be about making sure that we’re picking the right names. We do have a preference to be towards the more defensive part of the high yield market at the moment. So, we’re overweight single-Bs relative to triple-C [rated bonds]. So, that would just be a way of showcasing that we are more defensive in the high yield space.

MB: Got it, and there was a second thing I was going to ask you as well. You touched on agency MBS and you talked about securitised. I don’t know about a lot of our listeners, but when you hear the word, securitised, it sometimes takes you back to the financial crisis, when you think about CDOs and everything that happened there. So, it might be worth just hearing from you about the distinction between the different types of securitised options, and why you’re seeing value there and why it’s not like an 2008 type of conversation.

KM: Yes. I think that… I get that people have been concerned about what happened in the GFC, but there has been a lot of regulation that has been put in place to make the structures in that market safer and more protected and credit enhancements are in place. But I would just say that the key thing to think about when you think about the securitised market, is that it is very high-quality. Around 90% of it is single-A plus. It’s very low volatility.

I think you’ve actually had some case studies where you’ve seen that the market is very liquid. So, if you look at the UK LDI [Liability-Driven Investment) crisis that we had, there was so many securitised assets being traded and there was always a bid for those assets. If you look back at COVID and the pandemic, there were some assets classes that you couldn’t trade, but you could trade agency MBS, you could trade triple-A CLO. So, I think for anyone that’s concerned about liquidity, there have been so many different environments where those asset classes have been tested in terms of their profile. You’re able to get a bid and trade them essentially.

MB: So, before we go deeper into some of the areas that we’ve touched upon as a group, we’ve talked collectively about equities and collectively about fixed income, some of the opportunities there, but I want to talk a little bit about regional and sector variation as well. Because we talked about dispersion as well, but we haven’t really talked about where some of those opportunities could be or the areas to avoid. So, I’ll open this up to anybody who wants to take the first go at it, to talk a little bit about the regional differences, especially maybe from an absolute return perspective right now.

LN: Yes, sure, and that’s something we spend a lot of time thinking about, particularly because we don’t have an equity or a fixed income benchmark essentially. It’s absolute return. It’s cash. So, we need to think very hard about deploying our investors’ capital into different markets. Where are the excesses? The excesses of being unwound we’re finding still in a lot of domestic US areas. There was a lot of direct stimulus, particularly of the consumer, but to some extent the corporate into the US.

I think when you look at balance sheets and financial leverage, again you could make an argument that low rates and this very loose monetary policy was taken advantage of more in the US, partly to good use for a number of years. But the unwind can be painful. So, there’s no substitute for hard work from an investment perspective here. You need to go through industry by industry, company by company, and identify those pressure points, start thinking about when cheap financing rolls off. What’s it replaced with? It may be slightly more expensive debt, or it might be equity. So, that could be in terms of the share count and dilution something to focus on.

On the long side, it’s striking that this relatively lower valuation that we’ve seen in a number of comparable businesses in Europe and the UK and then the US, is beginning to matter. It echoes some of the points we talked about earlier. Valuation matters. That doesn’t mean you can blindly run around buying cheap companies and being short or taking negative views on expensive ones.

But if you can find a catalyst and if you can understand where the pressure points are, again it’s almost back to stock picking as it used to be. So much so that I would characterise the opportunity set for certain areas within alternatives, and equity on long-short very much within that, this is the best environment for a decade.

RC: I’d even highlight within technology… I know we’re going to talk about AI later, but you’ve got some of the beneficiaries of key technology trends, but then you see the impact of tighter financing in areas like EVs and you’ve seen Elon talk about that at length. On the renewable side as well. Anything that is a high-ticket item that requires financing is under a lot more pressure.

We were meeting Apple last week, and on the flipside, telecom companies seem very happy to still finance you to buy an iPhone on a two-year plan and basically give you that financing for free. So, that has managed to hold up.

LN: Yes, it’s interesting that different corporate structures as well… As Richard said, actually the hurdle for a new entrant within an industry is obviously harder. So, there’s an impetus there. You have a higher profit and cashflow hurdle that you need to achieve. But we can look at the other side of that. Actually, the benefit to the incumbent, particularly those that have a strong balance sheet, that can self-finance, it again is very, very strong there.

If we take it on an actual step, looking back historically at the sort of business structures that used to dominate when rates were these levels, do we see the rebirth of the conglomerate structure going forward? That’s something we’re looking at hard into 2024. Deeply unfashionable for a long time, because why would you need to generate your own capital when capital was essentially free or near free from capital markets? Well, that’s very much not the case. We don’t think rates are going back to zero. We think we’re at this elevated range for a period of years now. Actually, maybe there is a benefit to these sorts of structures now. So, there’s a lot to think about into 2024.

MB: Great. Well, just a quick reminder that if you do have any questions, please feel free to send them through and questions are coming through. So, we’ll try to cover a couple now, or one question right now because it’s on fixed income. We spent quite a bit of time on fixed income. Then we’ll move into some different areas. But the question has come through which is, what about the prolonged rate curve inversion?

KM: Yes, it’s a tricky one. But it kind of goes back to what we were saying at the beginning. When you think about what’s going to happen, at the moment, there’s obviously a focus or there’s going to be… A steepener is where you want to play next year. You want to make sure that you’re long the front end and taking advantage of some of those attractive yields.

But it goes back to the case where yields are, it doesn’t really matter in the bigger picture. Your curve place matters, but you do have that cushion to any volatility on the curve as well, given where your yield is.

MB: Great. So, I’m going to open up this question to everyone but I’m going to start with you, Richard, as our technology expert. You hinted about AI. You said about AI before and it has dominated the headlines for 2023. I saw a number and tell me if this is wrong, which was predicting enterprise AI expenditure over the coming years, between now and 2027. It was around about $143 billion, which is around the 73% or 74% annual growth rate. So, massive numbers going towards AI.

So, how are you seeing this affect how you’re investing, what you’re looking for? Is it such a big opportunity right now?

RC: The short answer is, yes. We’ve tried to be naysayers on many technologies that we’ve felt have been overhyped in the past and even AI itself, until we saw the inflection with the launch of ChatGPT just over a year ago. I think that’s a really important point. It was just over a year ago. So, there are two misconceptions I get from the conversations I have with clients. One is, this is a theme, we’ve had themes before, and this is over a year after it started. I draw parallels with the launch of the iPhone in June 2007.

If you’re saying that the AI trade is over, it’s a bit like saying you sell the FANG in June 2008. Now, the worst performing FANG since then was Google with a 10x times return. Netflix takes the ticket with 100x times return since then.

Then the second misconception is that it’s just the Magnificent Seven, or it’s just NVIDIA, and you’ve got to think about how these technologies play out. You build the infrastructure first. So, go back to the internet, you had to build the fibre networks, you had to build the 3G, 4G, 5G networks, you had to build Android, you had to build iOS, and then you had all of the apps take advantage of that off the back of it.

It’s the same with AI. Today, we’re just training up large language models. So, there’s one company literally in the world that benefits and that’s NVIDIA. But anyway, once you scale out these GenAI products and services that you’re building on top of these large language models, you need inferencing, you need different types of infrastructure, the cloud platforms will benefit and then all of these apps, services and software that can leverage this will hopefully generate huge revenues and profits in the future, like the App Store was able to create over 15 years ago.

So, we still think there’s huge potential disruption coming from AI. Huge impact to the labour market, particularly white-collar productivity. Huge cost-savings and efficiency, and that should lead to tremendous profit growth opportunity. If we can find the leaders and winners in that, there are some great stock returns to be had in the technology sector as well as in other sectors if you can find the beneficiaries.

LN: We’re lucky, we’ve got an expert like Richard in-house to be able to talk about the revenue implications and the revenue winners from AI. But actually, we’ve spent a lot of time looking at the cost implications as well and this is far-reaching. You start thinking about it, it’s hard to identify a corporate almost anywhere in the world where there won’t be a first or a second order implication.

So, we’ve been looking at what percentage of cost bases are data or administrative in nature that could potentially be disintermediated by AI at a lower cost. Now, there are a few things to say here. One, that means we should be focusing on the cost side of the profit equation, not just revenue. But actually, there are clear social implications to that as well and it brings us back to these debates over employment and humans’ capitals impact from AI. So, all of this will feed in over the next few years.

RC: Luke’s talking about some of the short side of that. I think having done this a long time, and Alison Graham, my co-manager, has done this even longer, there is a return of some of that hype. So, you are seeing beneficiaries of AI and it reminds me of the .com beneficiaries.

They had a website, so the stock’s going to do great, and they’re going to use some AI, so the stock’s going to do great. I think you just have to be really careful in new technology waves to not get caught up in that hype and over exuberance, these AI ETFs that have Royal Caribbean in it, or Disney, or John Deere in it.

Actually, some of our biggest contributor positions this year were stocks that were in the AI disruption basket. So, they got indiscriminately sold on the consciousness of AI mattering this year, but the reality is, you talk to management teams again across the market and they’ve been focused and investing in this space for years now. So, there are some slightly bemused management teams that had been labelled as an AI loser, who were quite happy to show the markets what they’ve been doing and the benefits, revenue and cost that they expect to show in recent years. So, that was a shorter-term tactical opportunity in this very, very long-term theme.

MB: So, that’s the beneficiary side of things. What about the flipside? So, when you talk about the losers, what sort of sectors, industries or companies are going to be on the losing side?

LN: Yes. Well, I think where we’re seeing businesses that lack the flexibility to be able to shift away from employing large labour forces and those are the sorts of frustrations that we’re likely to see. Where businesses have underinvested in their proposition and their model, those are the ones that seem to be being found out.

The other area that actually might seem less counterintuitive, but businesses that have an AI proposition and again we could hold an investor day and show you very fancy kit – but are hoping to monetise it. Because actually what… History never rhymes but it can repeat. Actually, the monetisation of some of these additional services within, I don’t know, music, education, these sorts of areas, that may be tough.

So, one thing we do is to look at share prices and work out in quite a quantitative fashion, what is priced in? What is the assumption for revenue? What’s the assumption for pricing and margin here? Actually, bizarrely, some of those perceived AI winners could actually feature in our short book going forward, if those hopes are overoptimistic.

KM: I think one thing that’s missing… It’s still opaque, it’s just that generally if you can going to expect high productivity from AI, then generally that does lead to an increase in capital expenditure from companies. I think post-COVID and the pandemic, we really haven’t seen that pick up generally on aggregate. So, that’s probably something to watch going forward.

RC: It’s pretty extraordinary, AMD held an AI launch event for their new chip last week and six months ago they had an investor day, and they sized the TAM as $150 billion. Six months later, it’s now $400 billion. Now, you can put a little bit of a grain of salt on that, but that’s the degree to which we’re seeing the size of these CapEx budgets potentially going up.

LN: Which brings us back again, without taking a step back, to discount rates. So again, I would say the CapEx in investment plans generally… Again, we’ve got to sense check versus a higher discount rate going forward, and again I think a lot of the structural technology investment plans look very underpinned, but actually… Whereas, this year, actually a lot of consumer investment plans were put on hold, reacting to a slightly softer consumer, actually we’re looking forward next year…

I think one of the areas that we’re paying most attention to for potential shorts that may struggle corporately and in share price terms is in the industrial world. Someone’s CapEx that starts to get impinged, because actually the discount rate is higher, IRRs are coming under pressure… Someone’s CapEx is someone else’s revenue and that’s a theme we’re watching very carefully into ’24 in terms of corporate CapEx decisions.

MB: Well, we’re almost at the Q&A section, so if you do have questions, please do send them through.

But before we get to that, there is one area we haven’t touched on and I’m going to throw it to the three of you and see who jumps on it first or doesn’t, which is talking about geopolitics. Because if we obviously look at this year, then there has been a real re-emergence of geopolitical tensions, which impacts fixed income, it impacts technology, it impacts the absolute return side of things in a very material way.

So, yes, how are you guys thinking about that? How are you positioning right now for all of these risks?

LN: I’ll go first. I think only because, yes, I think if you’re looking at absolute return or liquid alternatives, I think you can demand as an investor some marriage of long-term investment with a realisation that actually there are known unknowns in the world and actually you do get these bouts of unexpected volatility. Again, we’ve talked about this much better environment for equity stock picking this year, but actually that’s against a background of two panics about US federal shutdowns, obviously ongoing conflicts in Ukraine, a new one in Israel, panics around AI and obesity drugs. All of this has injected volatility and uncertainty.

But I would come back to the rationality that that volatility has been seen. I’ll give you a brief example. The military conflicts, actually what you’ve seen in terms of implications for corporates and for commodities has been pretty rational. Where you’ve seen threats around commodities and oil supply and demand dynamics, actually you’ve had pretty rational responses. With the shutdowns, actually I would say strong historical precedence. We didn’t have a shutdown, but we’ve had two dress rehearsals of what it might look like. It looked a lot in the market’s mind like 2011. Embattled democrat president, a republican house looking to score points, and actually you saw pressure on US domestic equities, pressure on the dollar and actually, and this is what I think was difficult, you saw the oil price correlating on the down side as well.

So, a lot has been going on. It has been fast and furious. The reason I think you’re seeing smiles on the faces of active equity managers is that the volatility has been more rational and understandable, and if you can harness it correctly, you can protect in the first instance and then of course you can look to capitalise.

KM: I think when you look at the impact of the geopolitical risks that are happening, it does come down to how that translates, the transmission channels. So, if you look at the Ukraine and Russia conflict, for example, that definitely transmissioned when you think about the energy sector, or when you think about utilities. I think that’s the thing, it’s about thinking about, how does it impact certain sectors within the portfolio?

When you’re thinking about some of the businesses and you think about the crisis in the Middle East, and actually all of these geopolitical risks, I think you’re definitely going to see a shift of investors moving to more global-type portfolios and strategies. Also, that’s something that as a team, like in fixed income, our research analysts are always thinking about, are we in businesses that have a global multinational business that can weather such storms really.

RC: I was going to say, just a couple of points. One, I’ve been an Asian tech investor for 20 years and I have friends in Taiwana and Korea. Geopolitics and that threat is not new. It’s just the great minds in the Pentagon figured out that most of their semiconductors are made on an island off the coast of China only recently.

Then the other element is that move to deglobalisation. Generally, we find the biggest impediment to new technology adoption is just status quo, incumbency. Things are fine. I don’t want to spend new money and new CapEx on some new-fangled technology. But then you get COVID. Then you get inflation. Then you get all sorts of… High cost of capital. You have to move your supply chain from China and everything else that has happened in Russia/Ukraine. Then you suddenly need to change and your ROI on that investment suddenly gets very different when you’re thinking about automating a factory, because you’re bringing that back to the US, because you need to be eligible for IRA subsidies, or whatever it is. So, as you say, there are opportunities and risks, and that really plays to the active manager, the bottom-up stock pickers who truly fundamentally understand the opportunities and risks from geopolitics.

MB: You mentioned China. How are you thinking about China then and how much of an impact will Chinese growth next year have on the technology sector?

RC: China is… Actually, one of our managers was retiring and he said the one thing he’s not going to miss is waking up and seeing China going down every single day.

I’ve been a China tech investor for 20 years and this is the worst I’ve ever seen it. Now, that’s a function of a couple of things, but some are structural, some are more temporary. I think one is the fact that one of the great investment themes in Chinese tech investing has been the rise of the internet and that’s just more mature. Then you’re waiting for the new technology trend, which is AI, and because of some of the restrictions the US have put on China, that’s just a lot more risk intensive as an investor and also will just be quite constrained by not being able to access the latest and greatest in video chip.

Valuations are obviously very low and so there’s so much negative sentiment towards China. It wouldn’t take much to get it going, but there’s a huge opportunity cost of sitting in that when US tech is doing so well. So, again, as active managers we can very much sit there and say, has something fundamentally changed? Now is the time to take up that exposure. That is the contrarian trade of 2024, that China outperforms the US.

LN: We don’t invest directly in China, but actually we’ve got a small short position. When I look through in terms of exposures, you can see where the risks have been. But I would echo Richard’s points there. We’ve seen this before where actually stimulus plans can get turned on and actually the picture can turn dramatically quickly.

I wonder, and again this is speculation of something we stay live and alert on, but I remember in 2015 and 2016, actually the stimulus approach was very much fixed capital formation. Actually, the best way for investors to benefit from that and get exposure was through the resource and the mining companies. I wonder if, and we’re trying to read the clues when it comes to the shape of the stimulus in China going forward, if indeed we do see more, probably a bit more focus on the consumer and consumption. So, that probably requires a slightly different investment approach to capitalise on it if that’s what we do see.

MB: In your response before, Richard, you mentioned about the US. So, this is just touching on one other thing that’s happening in the US as far as looking forward to elections… I’m not asking you to predict what’s going to happen or have a view on that. But how do you think the market is going to react between now and then, and how are you thinking about that when it comes to portfolio positioning?

LN: It’s worth saying, in 2016, we… One of the licenses that you can have within alternatives is to move to cash and actually we moved dramatically to cash. 50% to cash the day before the election to allow us to deploy afterwards. I think we’re going to have to use all of those tools to be flexible, because the uncertainties are extremely wide again. Some of this will echo the debates we’ve had before. Some could well be new going forward.

So, again, it feels like the stakes are higher. The stakes are higher because so much has been spent and actually we’re probably looking more as the fiscal consequences than the monetary ones now, given everything we’ve talked about now. But you can see the battlelines of the debate around the IRA plan in particular. That’s the one that feels very live at the moment. Can these incentive plans be justified, or do we see a very dramatic change?

It will be interesting… We’re having these discussions with corporates. Do you get a degree of sitting on hands, a bit of hiatus until we know the answer? Or do corporates look to move before we actually answer them? So, it’s going to be another known/unknown source of volatility this year.

RC: That’s an important point. The fiscal well is dry. We’ve seen that in Germany recently. That will be a major debating point of all the elections we’re seeing globally and there are quite a few next year. I think as investors though, when we think about, where should we be giving our clients exposure to, it’s the areas where we feel the most comfortable that are resilient. That might be something that actually both parties agree on, like national security in the US, or reshoring, or it could be the productivity gains you get from AI, which we see as a bit more cyber security, which we feel is a bit more ringfenced.

LN: Data centres, where at least you can see corporate decision-making and financing of them, rather than perhaps some of the government-backed schemes.

MB: So, as we’re on the US and we’ve had a question come in about the US dollar… Again, anyone can answer this, but Kareena, I might start with you. It’s about how you and the team are thinking about the positioning of the US dollar.

KM: We don’t specifically take active currency risk for us. But I think in general, just looking at the US economy and where it is at the moment, it’s in a better place in the sense that you’ve obviously got a soft-landing priced in here.

People are more used… The situation is worse in Europe and the UK than it is in the US. So, overall, the outlook is positive generally for the US dollar. Now, obviously, the events of next year and the elections could drive some volatility there, but generally I would say that’s the view that I’m seeing in most economic pieces.

LN: From our side, the short-term consequences is one that needs to be tackled today, because actually we’re already seeing… This is a shorter-term observation, but translational downgrade risk from this weaker dollar that we’ve already seen. Again, it’s very hard to forecast what will happen, but we’re sat here today in London. There will certainly be a lag, won’t there? If we are at the peak and we do see some cuts, and I don’t know, in the US, the US we know has got stickier and more persistent inflation. It’s going to be very difficult for the Bank of England to be able to move.

So, we probably are looking at a bit more volatility in terms of currency pairs. There was a FTSE listed company, British American Tobacco, who issued a fairly lack-lustre trading statement last week. We had 10% downgrades, but around half of that downgrade was currency mark to market, from a weaker dollar. Because they’ve got a big US business and they report in sterling. So, that’s a lot of the London market. It’s a lot of the European market. That’s a new headwind that we’re going to have to be dealing with over the next few weeks and months. So, for an absolute return fund within equity long-short, that’s something that is a live consideration, even if over the long-term that currency volatility tends to balance out.

MB: So, there’s a question that has come through and I’ve been looking forward to asking this one for a little while. Which is, we’ve talked about dispersion and the greater dispersion is great for active management. However, does that mean there’s more risk in selecting a winning manager? It’s more of a statement than a question, but any response?

RC: Yes, I think just given what we’ve talked about in terms of this being a higher dispersion, a very different market environment to pretty much everything we’ve seen since 2009, I think for clients, investing with investment managers and teams that can show a longer-term track-record, that actually they’ve done this when rates weren’t zero or there wasn’t QE, or there was geopolitics, or recessions… Actually, you have to be quite old and have a bit of grey hair to be able to do that or be able to show you that.

But I do think that experience counts, and actually we see, particularly in the last couple of years, a lot of managers only really have invested in that world of free money and have been caught out. They can’t really demonstrate that they know how to invest or demonstrate they can deliver great alpha in a world where there is a return of the cost to capital. So, I do think experience counts in a world that we’ve just articulated as pretty volatile and murky out there.

KM: I think it’s generally also about your research as well and the bottom-up side. Like Luke mentioned before, when you’re figuring out what fair valuations are, they actually matter now. So, it’s a much better environment for us because the work that you’re doing is paying off.

So, I think if you can be with a manager that can showcase that they’ve got strong research skills, that would be a key focus going forward.

LN: I get all of that, but it’s not quite the question you asked, but actually picks up risk then actually when you’ve got rational markets and valuation matters, and drawing together threads of what we’ve talked about, it means we can construct a portfolio that has… It’s easier to balance risks. I’m not going to say it’s necessarily lower risk, but actually if you’ve got rational feed-through, you can start to hedge and balance risk in a more efficient way going forward. That is a huge, huge advantage to active managers than it has been over recent years.

MB: So, another question that has come through is, analyst forecasts, how accurate are they? It’s not a leading question.

LN: I mean, they’re notoriously inaccurate. But that’s fine. Again, as you’d expect, we do a lot of our own work here and actually the value to even inaccurate forecasts is often that those may be factored into an instrument or a share price or credit assumptions. So, there’s value when they’re wrong as much as when they’re right. It’s all about building up in this more rational world, building up a picture of what the assumptions are.

Really, we’re back to… Particularly for equities, but the elements in fixed income as well, these are instruments that discount the future. So, actually, identifying where they’re wrong as well as right in terms of those assumptions can be valuable to our investors.

MB: Anyone else want to…?

KM: I feel as though when you… There was a survey recently… I can’t remember who it was, but there was basically a question about, when is the recession going to hit? You had all the different quarters over the next three years and the dispersion was just insane. So, I think obviously, as you mentioned, it’s important to see the different views. But I think it’s up to you to do the work and focus… I think there are lots of things that are rational out there, but it’s very dispersed.

I’m talking about recession specifically, but it’s very hard to call some of these market events and the exact timing, as we know is the case.

MB: We’re going to do a full house. I want to hear your view as well.

RC: Yes, I think it’s an important question, because it is the key to what we do. A lot of clients asking me about, well, you look at the growth of this company, or this company is on a PE of 100, but you’re presuming that the E is right. So, a lot of people have said to me, how can you own NVIDIA? It’s so expensive. It’s like, well, that’s because people thought there were going to do $6 of EPS and they ended up doing $18. That’s ultimately what gives us a job.

If sell side analysts got the numbers absolutely perfect, there would be absolutely no need for us to do all the research to think, no, actually, they’re going to earn a lot more money than people think. Now, the technology sector is particularly good for that, just given the disruption you get for tech both on the positive side as well as on the negative side. But that’s ultimately why I’ve got a job and hopefully in an AI world, I still will.

Right. Another question that’s come through… What lessons do you all take from 2023 to carry into 2024? We’ll start with you, Richard.

RC: I’d maybe take a slightly tangential one. There’s a misunderstanding of the impact of rate. So, we can debate rates until the cows come home. I don’t often quote Donald Rumsfeld, but given you started it, Luke, I’ll run with it. But there are these known unknowns and unknown unknowns. So, this known unknown was that rates would go up and that’s bad for growth stocks. But actually people didn’t think that maybe that’s bad for asset liability mismatch for some of the more exposed banks, or that it’s tough to get financing for certain things.

The impact on other sectors that had high leverage, that were meant to be defensive, like REITs, or telcos, or utilities… My utility, Thames Water, almost went bust over the summer. They’re a water utility. How does that even happen? Now, tech companies are meant to be volatile. But actually, if you’ve got stronger balance sheets, the fact that rates have gone up and that might compress your valuation, yes, but you’re not going to go bust overnight like a bank or some of these companies.

So, I think once we know about it and we’re discussing it, I generally don’t worry about it so much. It’s the stuff that you don’t know to worry about that you should really worry about. So, I’ll maybe take it a bit more intellectual and say a bit more Black Swan and Nassim Taleb than Donald Rumsfeld.

KM: Yes, I think that you need to… It’s not just about the fundamentals and the valuations, but it’s also about understanding the technical picture and how that has been playing out. I think that was a key thing. You’re never going to be able to time what’s going on in markets, but there are so many technicals that are feeding through in terms of supply and demand imbalances that are going to impact what’s happening going forward, and some of that you have to navigate. The way that you can navigate some of that is through your picks and your fundamental research. It’s through diversification.

But there are things that are going to happen that you’re not necessarily going to be able to control from fundamentals and valuation, so you just need to make sure that you’re in the pockets of your investment universe that are best to weather any potential storms.

LN: We’ve literally been going back to previous portfolios to remind ourselves how to invest in this period, and that’s really been the big learning for this year. That correlations can change. That new correlations can come together. They could be similar to what you’ve seen before or totally different. Actually, I think some of the impacts of this dramatic coordinated shift in financing rates, maybe we haven’t seen the full impact of that yet.

KM: It’s the technicals… Going back to the technicals, everything in the market fundamentally was telling you that… Everyone had talked about a recession for how long, right? Everything was pointing to that. But if we talk about credit specifically, it has just not come through into credit. You haven’t seen it. Some of that might be that you’re in a different market. There has been a regime shift. You’ve obviously got some of the impacts of what has happened over the pandemic and how that has fed through into companies now having better cashflow and the impact of that whole era.

So, there are lots of things to juggle. But for us, credit spreads were looking tight, but yields are looking attractive. So, that technical took over really over 2023.

MB: So, we’re almost out of time. We’ve only got a minute or so left, but there’s one question I want to squeeze in. I’m going to ask for a really quick response for an opportunity and a threat. You probably know where this is going. Talking about next year, what is the opportunity that makes you most excited and what is the biggest risk that you see? So, I’m going to start on my left.

LN: Okay, so opportunity, and I think you could’ve alluded to it earlier, you could’ve made this case multiple times over the last few years… I think the picture in domestic UK and Europe is not as bad as priced in. We all… Loads of you who are watching this in Europe will know it’s challenging, but actually there’s a lot of bad news priced in. So, that’s interesting.

Threats, I’d say the big short call for us in 2022 was, sorry, Richard, technology. That was very beneficial to the portfolio. This year, it has been the consumer-facing stocks. That industrial risk. Industrial later-cycle CapEx feels really vulnerable to us here, so that’s what we’re looking for as a risk.

RC: You’re not going to be surprised to hear, I do think the opportunity in AI broadens out, and so you’re going to see a lot more opportunities to invest in a wider range of stocks than you saw this year. Then on the risk side, you sold on one for me, which is just something breaks. With the tide going up of higher rates, we haven’t quite seen the full ramifications of that and something does break in the system somewhere. That’s probably an unknown unknown. So the Black Swan type of event.

But then on the other side it’s that actually AI isn’t linear. The adoption curve of that… There are a lot of hope and dreams, and actually that doesn’t play-out in the next 12 months. Maybe it’s 36 months and it ends up being way bigger than you thought, but a bit like the internet, you have a fallow period for 12 months, where people actually rachet back on some of that.

KM: Fixed income is the opportunity, right? I think there are loads of areas of fixed income that are attractive. We talked about securitised, but talking more macro, I would say the divergence in policy. You’ve obviously had central banks working towards the same goal of reducing inflation and now you’re going to see that divergence. That’s exciting, because it creates an opportunity for us to exploit opportunities there, opportunities for us to exploit those divergences to actually add alpha in the portfolio.

In terms of threats, it’s sort of the same as what Luke and Richard are saying. It’s the unknowns. I think a US recession is not priced in and if anything goes wrong, it’s going to be a tricky environment.

MB: Great. Well, I think that’s very much us out of time. So, what a great way to wrap-up the webcast and also the year. A big thank you to our guests, Kareena, Richard and Luke, and finally I’d like to thank all of you on the webcast for joining us. I wish you a very pleasant rest of the day.

JHI

JHI