I have always considered investing across the British listed equity markets akin to panning for gold. You need to sift through a lot of silt and sunken sediment to find the nuggets.

And that sediment has really sunk recently. Smaller companies have had a particularly hard time. The Alternative Investment Market is down 35 per cent this year; the FTSE 250 is down 26 per cent. By comparison, the FTSE 100 is down just under 8 per cent¹.

But even within the FTSE 100 there is a big bifurcation of performance. The biggest 20 companies, including oil giants Shell and BP, have delivered 7.9 per cent, while the remaining 80 have lost 26.2 per cent².

The worst performers are those companies deemed likely to be hardest hit by a recession as we all slash our spending so we can afford to cook dinner and turn on the heating.

There are two questions I am asking myself each day. Are markets being too gloomy? And have they got the story wrong on some companies?

There is no doubt that the market is glum. Think back to the start of the Covid pandemic and lockdown. At that point we were unsure of how many companies would survive. Frankly, many of us were worried about whether we would survive.

How shares performed in this period is arguably a useful benchmark against which to measure today’s situation.

Take sofa manufacturer DFS. Its share price fell nearly 60 per cent from £2.82 at the start of 2020 to £1.16 by Easter. We may have all been stuck at home on our sofas, but how many people were thinking of buying a new one when their jobs were in jeopardy? And who would have built them anyway, given that most of the company’s stock is made to order and factories were closed? By June last year the shares had recovered to £3. Where are they today? As I write, they are 60 per cent lower at £1.05. M&S’s share price fell 53 per cent during Covid. It recovered but is down 56 per cent so far this year³.

Unless you are an American tourist enjoying the benefit of the weak pound, the UK is unloved. September saw the largest redemptions from UK focused funds on record, with the bulk from equity portfolios. Investors withdrew £26.6bn – more than in the Global Financial Crisis or during the pandemic sell-off⁴. This year has seen outflows of around £16 billion from UK equity markets – the worst in 20 years.

Yes, share prices could fall further. Looking across the listed sector, though, you get the sense that markets are pricing in something not far from a doomsday scenario for British stocks.

Experienced investors might deem this the time to start buying – if only gradually. If you want a bit more insurance, look at UK investment trusts. I am not particularly plugging my own here. The Association of Investment Companies says investment trusts as a whole are trading at their biggest discount in a decade – on average 15 per cent⁵. That means you get £10 worth of assets for £8.50.

That is one way to get a bit of extra cushion. Another way to approach the issue is to look for companies that the market may have misunderstood – better still, the investment trusts looking for these companies!

The cyclical companies have arguably been the worst beaten, but I would argue that some have more about them than investors realise. We have begun making space for them in our portfolios. We like businesses that are heading into the forecast recession well prepared, with decent balance sheets and costs under control. If the recession is not as bad as feared – or when it ends – their sales could pick up quickly, and those financial disciplines could lead to very good operating margins and earnings upgrades beyond people’s present imagination.

Fitting this category, we believe, is Halfords. People still think of Halfords as a cycle shop and a place to buy motor parts – car mats, hubcaps and windscreen washer liquid. But the company is much more than that these days. In the past three years it has invested heavily in servicing and the fitting of tyres and parts. It has almost doubled the number of garages it has – to 606. It has created 445 mobile vans, delivering fitting services to the home. Nearly 40 per cent of its group revenue now comes from services⁶.

You may have abandoned your car for a pushbike (Halfords can still help there). You may be putting off replacing windscreen wipers. But you cannot delay having your MOT. And that makes it harder to put off replacing brakes and tyres. Halfords’ share price is down 54 per cent this year. It yields over 5 per cent.

We recently bought housebuilder Bellway Homes. Bellway’s share price halved in the first half of 2020. It recovered. It has halved again so far this year. Lots of housebuilders currently trade on half what their stock of land, property and other tangible assets are worth. Bellway is as cheap as it has probably been in over 80 years⁷.

The market is pricing in falls of up to 30 per cent in house prices. Bellway has a three-year land bank – an asset in short supply. It is yielding 8 per cent currently. Another housebuilder we like is Scotland’s Springfield homes, which we hold in the Henderson’s Opportunities Trust. It is a similar story. It yields nearly 7 per cent. You are being paid well to wait for recovery.

I would consider these potential nuggets. You may find others in the industrials sector. One example is precision engineering firm IMI, which makes valves for liquified natural gas (LNG) terminals. We are likely to see more of these built in the wake of the war in Ukraine. It also builds equipment used for climate control in buildings – an area of growing demand. Large parts of its business should be resilient in the face of recession. Its share price is down 34 per cent this year.

This is not the Klondike. I am not expecting a gold rush yet – though the number of overseas buyers hovering around British companies shows that others are seeing through to the other side of the gloom. Experience tells me that at some point the mood will change. You might want to start panning for those nuggets while they are still reasonably easy to find.

James Henderson is co-manager of the Henderson Opportunities Trust and the Lowland Investment Company