Mark Hawtin discusses what is driving equity markets and the summer of extreme volatility, including the fact we are at potential pivot points for economic data and the role of passives.
SH: Hello I am Simon Hildrey, and I am with Mark Hawtin, Head of Global Equities at Liontrust, to talk about the outlook for markets. Mark, over the summer we've seen an increase in volatility in global markets. What's driving this?
MH: It's been a fascinating time for sure. At the end of July and going into August, we saw extreme volatility, and frankly from my own perspective it felt for a little bit like 1987. It came out of nowhere, there was a lot of uncertainty. There was one weekend where we woke up on a Monday morning to find the Japanese market had fallen by over 10%. And everybody was scratching their heads. But I think what's happening here is that we're at a key pivot point in terms of a number of key data points for markets. It's not entirely clear yet whether inflation is totally tamed. And therefore, it's not entirely clear what the path of interest rates will look like over the next one to two years. At the same time economies are slowing, but there are all sorts of different signals about how fast and how deep. On top of that, we've got this increasing concentration among major names in the stock market and the way in which investors invest in those markets. There's a big increase in passive investing – it has passed 50% of all fund investing for the first time this year.
SH: So let's unpick a couple of those things. Starting with the passive, is that concentration risk and the rise of passives making markets more volatile do you think? Or will it do going forward?
MH: I think they could do. I'm not saying they necessarily will and in some senses they can make the markets less volatile. Because if the market is trending in one direction, then passives help support that trend. So, when markets are moving up, as they have done for most of the last few years, that passive flow supports that up move. And therefore, investors have done very well by just buying dips in markets because the passives have come in and continued to push the markets higher. But I think what tends to get forgotten is that one of the features of passive investing is that, unlike active investing, it is valuation agnostic, so it doesn't care what the value of a stock is. And therefore, this could also happen in reverse. So, if we were to get a change in the fundamentals for markets which started to cause a downturn or a more prolonged downturn, that could lead the passive investors to start moving the market in the opposite direction. That could increase volatility quite dramatically and it's something that I think investors need to be aware of.
SH: And what could drive that change in the fundamentals? What do you think is the most dangerous thing? Earnings, interest rates, economic growth?
MH: I think the catalyst will come from the macro side. It'll be a misstep in terms of maybe interest rate policy. It may be that growth ends up being much slower than expected or maybe we do indeed dip into recession – this is not clear, particularly in the United States yet. Now if that were to happen, that might be the catalytic point for a sharper downturn in markets. And then this passive flow factor would come in and accelerate that move and raise that volatility.
SH Are you worried about interest rates and economic growth, or is it just uncertain?
MH: I think it's uncertain. From my perspective, the base case is that growth will be slow but will not dip into recession. And, that rates will start to come down, maybe not as aggressively as some may like, but it will create a kind of Goldilocks scenario, and that should be fine for markets. But I think the real opportunity actually lies in where one's invested. I think by looking at different investment alternatives, maybe not focusing on the names that have done so well in the last six to 12 months but diversifying into other names may be a good way of performing over the second half of this year.
SH: Can you give us a flavour, a little taste of where you're invested or what you like at the moment?
MH: The passive theme is focusing on particularly the ‘Magnificent 7’ names because they're very dominant in the passive investment vehicles. Over half of all the passive vehicles are S&P trackers, so this funnels money into those big names. While we still like those a lot, we're tending to downscale the size of those positions and look for positions that aren't within the main indices – names which essentially are not being invested in by those passive flows, and where there's a big gap in fundamental valuation between that type of name, that maybe has significant upside and perhaps some of the more passively occupied names which have less upside.
SH: Could you give us one or two names as examples to illustrate that?
MH: I think, first of all, look at it from a sector perspective. We are tending to look now at sectors outside the mainstream winners so far. So, we're looking outside technology or direct technology biased names, but we are still looking for companies that benefit from the use of technology. We'd like to find the consumer companies that benefit from using technology. Among the biggest names, we think that Meta is perhaps the best name to invest in because it's the clear first stage winner from the use of AI, which is the most popular technology and topic of the moment. And then I think below that we're looking at some of the other industrial names, healthcare names, names that are using technology effectively to drive their businesses, but which are not so dependent on either the passive flow or the technology flavour of the moment.
SH: Great. Thank you, Mark. And thank you for watching. We'll see you next time.
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