Markets at risk of “complacency”

Published on 24 June 2024

The first half of 2024 has seen unrelenting economic and political uncertainty, but little of that has been reflected in the markets. Bhavin Shah, fund manager at Newton Investment Management says that markets run the risk of “complacency” and tells us why he is cautious on valuations.

In this episode, he discusses what he sees as the top risks and what trading desks should be paying attention to this week and for the rest of the year. He delves into the growing debt deficits, potential election volatility, and whether we’re seeing over-concentration in the US tech sector.  

The fund manager also unpacks his outlook on rate cuts this year and how his team are positioning their portfolios.

Interview Transcript

Jo Gallagher Welcome to Trader TV This Week your insight into how trading desks can prepare for the week ahead. I’m Jo Gallagher and today I’m joined by Bhavin Shah at Newton Investment Management to discuss the main topics and events leading this week. Bhavin welcome to the show!

Bhavin Shah It’s great to be here.

Jo Gallagher Looking ahead, what are the main risks and events informing your portfolio construction?

Bhavin Shah The upcoming weeks actually fairly light on economic data, but if we look at the last couple of weeks and some of the key data points that markets have been focusing on, we’ve had the major central banks rate decisions, such as the Federal Reserve keeping interest rates on hold, as did the MBC.

The eurozone has cut rates, but the commentary that’s coming out of both the Federal Reserve and the UK embassy is more dovish. So you start seeing a fall in headline inflation numbers. Although core and services remain very, very sticky. With employment data also looking weaker. This is leaving the central banks more room to cut rates.

So in terms of our portfolios, we still have a high weighting in equities. Although we have been reducing that. We’ve been increasing our fixed income exposure as interest rates remain high and they provide positive real yields. And this provides diversification, especially in the event of an economic slowdown.

Jo Gallagher We’re living in a time where market uncertainty is at an all-time high, yet none of that seems to be priced in. What are your thoughts on that?

Bhavin Shah So equity volatility remains very, very benign. It’s started to increase but albeit from very very low levels. And actually, fixed income market volatility is at an elevated level to what we’ve seen over the past decade, although that is coming off it. So I say there does appear to be complacency in the market. But often markets continue to run until there’s a catalyst and there’s a reason for markets to worry. So for example, governments are running large fiscal deficits at the moment. No one seems to be concerned about that because there is expectations for rate cuts to come into the market.

However, as we have seen, if the market starts worrying about how these are funded, that can cause panic within the market.

Currently there is fragility that is governed by concentration risks. So in particular in the S&P 500, the top ten companies are making up almost a third of the index. If you look at that across the globe, the MSCI world all countries, the US makes up over 60% of the index today. And that’s in comparison to 25% of world GDP. So as you can see there is a mismatch between these two levels.

Jo Gallagher Are we seeing a tech or semiconductor bubble in the US or how concerned are you about overconcentration?

Bhavin Shah The semiconductor sector has gone through a secular tailwind driven by digitalization, automation and increased electrification. The next leg of this growth journey is artificial intelligence and in particular, generative artificial intelligence. This has led to a rerating in the sector. Semiconductor companies as a whole are now trading at similar valuations to software companies. These are very different businesses. The semiconductor sector as a whole is much more cyclical in nature and much more CapEx intensive. Given some of these concentration risks, we are cautious of valuations in the market.

Jo Gallagher What is the top risk the trading desk needs to be paying attention to right now and why?

Bhavin Shah So I’d be looking at headline levels in equity markets. I think the index as a whole is masking a lot of uncertainty in markets, but actually where I’d be looking for the catalyst and for the monitors within that are within the fixed-income market. So we’ve talked about government deficits at significant highs, so fiscal deficits. In particular, the US are running at 6% to 7%.

In the eurozone, they’re running at 4% to 5%. You’re seeing large spending that is being promised that has been legislated for. So within that, so you’ve got about $1 trillion of spending across several different acts in the US,  the Infrastructure Bill, the Inflation Reduction Act, and the Chips Act. Of that, only 20% has been spent so far. So that provides lots of opportunities.

But if the market worries about how that is going to be funded through extra tariffs, etc., etc., that could be a catalyst. And that’s why a focus on valuation is crucial. So within our portfolios, we’ve been trying to actually focus on areas that are less cyclical in nature and have more supportive valuations. So we’ve been reducing our exposure to technology companies at high valuations and looking to invest more in some of those industrials and health care companies that are much more attractive valuations.

Jo Gallagher We have elections coming up in the UK and Europe, and then a major election coming up in the US later this year. How much of an impact do you see these elections having on markets?

Bhavin Shah Elections can be significant for markets, especially when you get uncertainty and outcome. So for example, we had the Indian elections recently where there was an expectation for the incumbent to have a large majority. Actually, it was much more closely contested than the market expected. And that had an impact on equity markets.

Alongside that, you’ve seen the surprise elections in Europe and you’ve seen actually a rise in populism in terms of actually some of the outcomes that you’re seeing within that. So this leads to greater uncertainty across markets. So whilst it’s very difficult to predict the outcomes of any election, the market will be focused on the US election in particular in the second half of the year.

The one thing that we are very clear on is whichever candidate wins, they will continue to spend and therefore the fiscal deficits matter. So the key focus for us is going to be focusing on the long end of the bond curve and making sure that the market feels that these deficits can be funded. And actually keeping an eye on equity valuations.

Jo Gallagher Thank you, Bhavin, and for your insight and thank you for watching. This is being Trader TV This Week.

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(markets, risk, fund manager, market complacency)