Multi-Asset: High Alert

On the Mark
EPIC Investment Partners Multi-Asset Team
March 2023

• The Global Financial Crisis and subsequent fiscal stimulus supported the extreme outperformance of tech and growth
• The removal of stimulus has led to an unwinding of outperformance
• As a result, an opportunity in growth stocks beckons in 2023

If you can cast your mind back to October 2020, we wrote the following in our On the Mark piece “the reward from holding growth style funds has been nothing short of spectacular this year.”

We highlighted the fact that the Polar Capital Global Technology Fund has a long track record spanning many market cycles and is therefore useful for context and statistical significance. We still believe this manager is ‘best in class’, but the fund has exhibited one of the most extreme out-performance readings of the information ratio (“IR”) we have seen (Figure 1). By the end of September 2020, the IR had expanded to an amazing +5.0, unequivocally breaching the previous c.19-year range of -2.0 to +4.0.

Figure 1: Polar Cap Global Tech vs Global Equity Index Information Ratio

Source: EPIC, Bloomberg LP

Additionally, we stated that “it is fairly evident that Covid-19 has accelerated these existing trends and given the sector, and this fund, a ‘super charged’ period of performance.” For further proof of this, we have shown the equivalent IR ratio for a recognised growth global equity index, vs. the corresponding value global equity index (Figure 2).

Figure 2: ‘Growth’ vs ‘Value’ Global Equity Index Information Ratio

Source: EPIC, Bloomberg LP

We also referenced Ned Davis Research’s analysis of historic bubbles, noting that the extreme dominance of Tech/Growth in recent performance and its close correlation with the NDR Historic Bubble Composite warranted monitoring, with the propensity for a correction after such levels of outperformance.

Whilst we highlighted the obvious risks in this sector and stated that a rotation was highly likely we did not fully appreciate the magnitude of the unwind that would ensue.

Our current outlook on equities tends to resonate with Mike Wilson of Morgan Stanley in that we see a recession and wage pressures harming earnings and margins respectively. As Wilson says “while a peak in inflation would support bond markets, it’s also very negative for profitability“. In short, more downside potential in H1 2023.

Equally Kostin at Goldman Sachs argues that “the biggest risk in 2023 is a potential recession, in which case S&P 500 EPS could fall by 11% to $200 and the index could trough at 3150 (-19%).” 

However, by revisiting the comparison between the Polar Cap Global Technology Fund and global equities we see hope that the worst could be behind us (Figure 3). In the twenty plus years the fund has been operating the IR has never been this low. Whilst this does not mean that it could not reduce further, we are hopeful that a nadir has been reached or is very close, and we would hope to see an improvement in the risk/reward for this fund versus global equities. As a result, we believe that in the near term the future looks brighter for technology stocks or at the very least the Polar Cap Global Technology Fund.

Figure 3. Polar Cap Global Tech vs Global Equity Index Information Ratio

Source: EPIC, Bloomberg LP

Considering growth stocks more generally indicates that they are approaching the low point of the last twenty years. Although there is still some downside versus the all-time lows observed since 2002, we are hopeful of modest out performance of these assets relative to value style equities in the near future. A potential catalyst for this could be a slowing of inflation.

Figure 4. MSCI ACWI Growth vs MSCI ACWI Value 

Source: EPIC, Bloomberg LP

2022 saw a significant shift from negative to positive correlation between bonds and equities as highlighted in our commentary in November. This resulted in very poor returns for many assets including those normally considered defensive. We do not believe that we have reached the end of this underperformance, but are hopeful that there will be a brief respite as market participants refocus on a significant short term move downwards in headline inflation.

We have shared the views of Simon Ward of Money Moves Markets on several occasions and highlighted his expectation that inflation should reduce significantly in Q1 2023. This view aligns with that of Albert Edwards of Soc Gen who has noted the potential for a significant collapse in headline inflation amid recession risk and falling commodity prices, albeit he warns that this could merely set up a second wave of inflation akin to the 1970s. He observes that whilst headline CPI inflation might fall below zero, core CPI could remain closer to 3% despite the coming recession.

History tells us that once headline inflation exceeds 8%, it can take up to a decade before it stabilises at around the 3% mark. Should anything like this precedent play out, correlations between bonds and equities will likely once again turn positive, and all the consequences of such an outcome will resume. Nonetheless, in the meantime, there is some real value to be found in several areas of the fixed income markets, and historically a fall in bond yields has been beneficial for long-duration assets.

Mark Harris and Pushpanshu Prakash
Fund Managers, Multi Asset