Thomas McMahon, investment trust research manager at Kepler Trust Intelligence, picks out investing highlights from 2022, lessons learned and possible outcomes for 2023.
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Lee Wild, head of equity strategy, interactive investor: Hello. With me today I have Thomas McMahon, investment trust research manager at Kepler Trust Intelligence. Hi, Thomas.
Thomas McMahon, investment trust research manager at Kepler Trust Intelligence: Hi Lee.
Lee: Good to see you again. Last year, we talked about an incredible year for stocks. UK markets rose 14%. Wall Street was up 26%. 2022 has also been an incredible year, but for very different reasons. London’s blue-chip index is up 1-2%. US markets have plummeted though. This has clearly had a significant impact on the investment trust sector. So, what have been your highlights for 2022?
Thomas: Well, there haven't been many. It's been a pretty miserable year across the board. I think if you want to look for positive returns, the things that have stood out, a couple of trusts that have done well, BH Macro (LSE:BHMG) hedge fund, and Ruffer Investment Company (LSE:RICA), both of which used derivatives to try to protect or benefit from market shifts. They've generated good positive returns on a NAV basis. Infrastructure and real assets are still reporting positive returns at the time we're speaking. Property too, but that's very likely to change in the coming quarters, and share prices are down adjusting for expected falls. So aside from the hedge funds and protective strategies, it's really commodities and Latin America, which has a large exposure to commodities, that have generated positive returns. So the suite of BlackRock funds, BlackRock Energy and Resources Inc (LSE:BERI), BlackRock World Mining Trust (LSE:BRWM), BlackRock Latin American (LSE:BRLA), all have made good returns, but it's been pretty miserable aside from that to be honest.
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Lee: Thomas, were there any investment trusts that really stood out from the crowd in 2022? Did you learn any lessons?
Thomas: Well, I think we've been taught a few. We've been reminded of a few important lessons, important adages to bear in mind. I think central banks and investors have been very slow to react to a changing situation. At the start of the year, people were very complacent that we would return to pre-pandemic trends in terms of inflation and growth. Central banks assumed that what would happen in the economy would be just what happened after the previous crisis, and investors correspondingly assumed that rate hikes would be shallower and briefer than expected and subsequently, when it comes to investment behaviour, they were very keen to buy the dip in growth. And in retrospect we can see that they bid up valuations very high, so I think it's perhaps a lesson to not be swayed by past correlations of past behaviour and try to reassess the situation that you're in right now. So I think that's been a struggle for all investors. It's really hard to pick things that have gone well frankly, and I think almost the whole market has been caught a bit off balance by how fast interest rates have increased and how fast inflation has increased.
Lee: There are so many potential outcomes in 2023. As you say, policymakers continue to tackle inflation and the cost-of-living crisis while also avoiding or at least softening the recession. What's your outlook for the next 12 months for 2023?
Thomas: Thanks very much for that question. So, I think my view has been that after markets kind of stabilised in the middle of the year, that probably we'd seen a repricing of duration sensitive assets and probably we were then going to see another leg down once the recession hit. When earnings started to come through, maybe we'd see equity markets take another hit. I think we're only now starting to see companies forced to see the impact of the coming recession in company earnings. You speak to fund managers on the ground, they're saying it's starting to come through in results, but it's still very much a case of, the recession has been looming for a while. And markets have been quite stable for a while again, and if you look at underlying valuations particularly, say, UK small caps, they seem to be pricing in already a very severe recession.
So, you have start to think that perhaps the risk/reward calculus has shifted back a bit. If the recession is just slightly softer than expected, then perhaps this is an interesting time to be looking at investing, and so to 2023 I think probably we will see some more market weakness before we get a recovery. If I had to make a random prediction I'd say, maybe the market doesn't bottom out till Q2. But I think probably that it is a good time to be thinking about adding risk, and by the end of next year I think perhaps investors will be back in the black.
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Lee: You're talking about the view of the policymakers and how they will react next year. Do you think interest rates might perhaps even begin to come down at the end of the year?
Thomas: Well, I'm not an economist, so take all of this with a pinch of salt, but I think that the central bankers were very slow to react to a new a new situation. I think they were expecting that there would be a lot more slack in the labour market than there really was. Their bias is firmly towards wanting to cut rates because that's how they've read the global economy, the UK economy in the past so, I think they probably do want to ease off and and cut rates, particularly the Bank of England, which arguably is being dragged by the Federal Reserve into raising rates when maybe they don't want to.
I think there's possibly a risk of them cutting rates too soon, maybe in the same way that the ECB did raise rates too early in 2011. In retrospect, it was seen as a big policy mistake, I think that's quite likely. I think that inflation will be high and choppy. You're going to see a lot of lagged effects, just because inflation has come down from 10% to 7%, let's say, in March, doesn't mean everybody's suddenly going to say, oh, well, in that case, I'm going to accept a 2% pay rise. People will want to see their pay increase, there is going to be a lot of inflationary pressures that are going to continue through the year, so I think perhaps a volatile rates and inflation environment is quite likely.
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