Investment strategy May 2014: Recovery in transition

Shaun Port

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Investment returns across global markets have been something of a mixed bag in recent weeks as there are signs we’re now moving into a new phase of the economic recovery. This is shaping the important investment decisions we make on behalf of our customers. In particular, we have started to gradually shift our investment focus towards equities in larger companies in the UK and Europe.  

While the FTSE 100 performed relatively well during April and bonds have produced steady returns, we’ve seen a dip in share valuations for small and mid-sized companies in both the UK and the US. This suggests we’re now moving out of the first phase of economic recovery and into what we call ‘the mid-cycle’ where growth is more likely to be led by larger companies.

Growing recovery                                    

In the most recent phase of the economic recovery, from around the summer of 2012, there has been a focus on smaller company stocks rather than large company stocks, or ‘large-cap’. This is because smaller companies benefit to a greater extent from falling borrowing rates, improved access to credit and a general rise in business confidence.

The emergence of the mid-cycle doesn’t mean that we expect small and mid-sized stocks to collapse, but going forward the momentum is likely to come from larger companies. We’ve already seen recently that mergers and acquisition activity by larger companies has picked up. And the looming potential for more business deals, improved efficiency and rising capital spending should all be good news for larger stocks.

Rate rise edging nearer

Another signifier of markets entering a new phase is that we’re getting much closer to a possible rise in interest rates. Here in the UK the first hike in the base rate was generally expected to come in May next year, but there is now a good probability attached to a rise by February 2015 and we think it could possibly come before the end of 2014.

Another interesting consideration in the UK at the moment is the impact we could see from rising political uncertainty, ahead of the Scottish referendum in September and the general election next year. This could add a degree of volatility to stocks which are most exposed to the UK economy, particularly as overseas investors were big buyers of UK stocks last year, and we are factoring this into our analysis.

Shifting focus in portfolios

In line with our view of the markets moving into a new phase, we have started scaling back our customers’ exposure to smaller companies across all regions, notably in Europe where we have sold all small-cap stocks, and we are reducing customers’ investments in UK mid-cap stocks. This money is being put into larger companies in both the UK and continental Europe.

We have also taken the opportunity to sell all holdings in low-grade corporate bonds, otherwise known as ‘high yield’ or junk bonds. After some strong gains this year, we think that junk bonds offer little value, compared to the risks, and so we have put this money from US bonds into higher-grade UK bonds.

Eurozone potential

We continue to favour equity investments in the peripheral European countries. Borrowing costs in countries like Spain, Portugal, Italy and Ireland have all fallen dramatically. In fact, the Italian government can now borrow at a lower rate than at any time in its history. This is supporting a steady rebound in growth and helping the banks recover.


Finally, in the commodity space, it looks likely that we will see an El Niño weather pattern this year.  This can have dramatic effects across the globe in many different ways. Some countries will experience high rainfall, some will endure drought. This can undoubtedly increase risk in certain countries, but it also means that for some commodities supply is likely to be constrained and prices will rise.

We will be closely monitoring developments in the coming months as we seek to manage any potential investment risks but also identify opportunities for unexpected or unusual investment returns.

About this update: This update was filmed in May 2014 and covers figures for the full month of April unless otherwise stated. Data sources: Bloomberg and Macrobond.

Risk warning: As with all investing your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.



Shaun Port
Shaun is the chief investment officer at Nutmeg. He has over 25 years’ experience developing and implementing investment strategies for clients ranging from central banks to pension schemes to charities and private individuals. Shaun holds a degree in Mathematical Economics from the University of Birmingham and is a Chartered Alternative Investment Analyst. He can be found tweeting @ShaunPort.

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