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Ways to capitalise on market uncertainty

Graham Smith

Graham Smith - Market Commentator

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

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2020 has certainly begun eventfully. China’s coronavirus will go down as the main detriment to stock market returns in January, but a number of other concerns featured too.

A record-breaking run for US markets into the New Year fuelled the debate as to whether US companies are now overvalued. Meanwhile, Brexit Day on 31 January brought into sharper focus differing perceptions in the EU and the UK about what a future trade deal might look like.

America’s VIX Index – sometimes referred to as the “investor fear gauge” – reflects a recent, rapid change in sentiment. Having bumped along the bottom in late 2019, investor fear has spiked moderately higher1. This index measures the cost of insuring against future adverse market movements using financial instruments.

Such spikes are nothing new and the one we have seen since mid-January figures almost nowhere on the all-time list – the Index was at more than three times its current level during the financial crisis of 2008. However, what the Index indicates is that the coronavirus and other concerns bubbling up have put cracks in market sentiment.

This was, perhaps, to have been expected. Significant gains on world markets in the second half of 2019 were largely built on hopes for an improvement in global growth, not evidence of one. Justification for last year’s market moves comes from an understanding that governments and central banks have taken and will continue to take appropriate action to support growth.

It’s early days to be making assessments about how the year ahead will pan out economically; whether a more comprehensive trade deal between the US and China will be forthcoming; whether actions on interest rates will feed through to higher growth; and whether company results will persuade investors to keep buying.

The main weapon investors can pitch against market volatility is a diversified portfolio approach. By investing in assets that tend to behave differently under a given set of economic conditions – shares, bonds, commodities, property etc. – large mistakes can be averted when the unexpected happens.

Including a few investment trusts as part of a long term investing strategy can be a good option too. Unlike the unit trusts and open ended investment companies (OEICS) we may be more familiar with, investment trusts usually trade either at a discount or premium to the value of their assets, reflecting how confident investors are.

Investment trusts predate unit trusts significantly. The oldest – the F&C Investment Trust – was launched in 1868 and continues to this day. Investment trust shares are traded on the stock exchange, as opposed to directly between a fund provider and an investor.

By investing when an investment trust’s assets are worth more than the trust’s market value – when the assets are at a discount, in other words – it’s possible to benefit twice from periods of depressed market sentiment. That’s once from low share prices generally and again from the discount.

Positively, America’s corporate season has gotten off to a good start. Some of the largest technology companies in the US and the world – including Amazon, Apple, Microsoft and Netflix – have reported quarterly results over the past couple of weeks that have surpassed expectations2.

That news will be welcome at the Scottish Mortgage Investment Trust, which invests globally but has a number of large holdings in American technology companies including Amazon, Netflix and Tesla.

This is not a prime example of an investment trust where investors can take advantage of buying at big discounts and selling at premiums. Historically, this well respected trust has traded quite close to the value of its underlying holdings.

However, Scottish Mortgage could benefit should the jitters surrounding growth investing styles of late last year continue to dissipate. The trust currently trades at about a small discount, compared to a 3% premium at the end of December3.

Improved market sentiment would be welcomed closer to home too. While the pound and shares in companies highly exposed to the UK economy received a boost from a clear-cut general election result and progress towards Brexit late last year, these rallies have run out of steam lately.

One reason for caution is the resurrection of the possibility of a no-deal Brexit at the end of this year. Putting together a comprehensive trade deal with the EU in the space of just nine months looks like a tall order, especially in light of comments out of London and Brussels this week revealing contrasting goals.

However, after several years in the international wilderness from an investing point of view, the UK stock market now looks as if it represents good value. In the current environment, smaller companies, which tend to be more domestically exposed than larger ones, may be worth another look.

The Standard Life UK Smaller Companies Trust is an example of a trust that has seen its discount narrow since last autumn, as investors have begun to seek out out smaller and mid-sized businesses with good prospects but depressed valuations4.

Finally, China looks set to remain a key focus in 2020. With many businesses still closed after the Chinese New Year due to the coronavirus, markets are preparing for a hit to economic growth in the first quarter of this year at least.

Positively, the response from China’s authorities has been swift. Interest rates were cut this week and money markets have been injected with large amounts of capital to ensure the economy keeps running smoothly5.

The Fidelity China Special Situations PLC investment trust currently sits on a discount of about 8%, despite its strong bias towards companies enjoying stronger year-on-year growth than the economy at large. Current large holdings include beneficiaries of the growth in consumer demand for online shopping (Alibaba) healthcare (China Biologic Products) and financial services (China Pacific Insurance)6.

Source:

Cboe, 05.02.20
Reuters, 30.01.20
3Baillie Gifford, 31.12.19
4Aberdeen Standard Investments, 31.12.19
5Reuters, 03.02.20
Fidelity International, 05.02.20

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The Standard Life UK Smaller Companies Trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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