Jason Hollands: Unloved stocks may yet shine again

a sound approach. But it is also advisable for investors with either new money to put into the market, or with portfolios that have not been reviewed for a while, to stand back and consider their approach from time to time.

When people review their investments, it is human nature to focus heavily on past performance and invest in the things that have already done well. Over the last decade many investors will have enjoyed supersonic gains from the likes of US technology stocks, global funds loaded up with hefty exposure to US shares and even plain old S&P 500 trackers. Unsurprisingly, investors have continued to throw ever more cash into these parts of the market, even while valuations have steadily become very expensive.

Alongside major changes in the way we shop, work, and entertain ourselves that have driven the growth of blockbuster US growth companies such as Apple, Amazon, Alphabet, Meta, and Microsoft, they have also been beneficiaries of

a combination of a long period of ultra-low borrowing costs and benign inflation since the global financial crisis. In such an environment, investors have been happy to pay a premium price today in expectation of the projected

profits that might be made by such firms over

the next several years.

Our love affair with growth stocks has been partially at the expense of “boring” companies generating dividends today, including those in “old economy” sectors that are well represented on the UK market. Whereas 29 per cent of the US market is comprised of technology shares, these represent a mere 2.5% of UK equities. What the UK stock market does have in abundance are financials, energy and commodity shares

that together make up 37% of the UK market. This has been a factor in holding in back the performance of the UK market during the growth stock boom of the last decade.

However, investing based solely on the past performing “winners” of recent years can be dangerous. It is a little like driving a car and staring into the rear-view mirror without paying any attention to the road ahead.

The question investors should be asking now

is whether it is time to reassess the types of business that might do well over the coming

few years given the climate we appear to be heading into.

Two major themes savers and investors should have firmly on their radars now are inflation and rising borrowing costs. Inflation is racing away globally, with the latest headline readings for the US and UK hitting 7% and 5.4% respectively. The Bank of England, which only last summer dismissed inflation as a ‘transitory’ effect as the economy rebounded from pandemic lockdowns, is now expecting it to hit 7% by Easter.

Rising borrowing costs follow inflation as surely as night follows day, as central banks try

to tame it by raising interest rates. The Bank

of England has already raised interest rates

twice since mid-December and called time on quantitative easing. The money markets are pricing in a bank rate of 1.5% by year-end, a level last seen 14 years ago. The US Federal Reserve is also on a path of higher rates too.

The twin forces of higher inflation and rising borrowing costs represent a seismic shift in the market environment investors have been used

to for a long period of time now. This is rattling the financial markets. Bond yields have moved sharply higher in recent months and the start of the year has been a turbulent period for “growth” stocks as sky-high valuations that were predicated on optimistic forecasts of future earnings are now being called into question by the greater level of risk implied by higher interest rates. Against this backdrop, businesses turning out healthy dividends today look appealing rather than dull.

Since the start of the year on a global basis technology shares have tumbled -9% and the jury is out whether this could play out further. But

it is not all bad news. In a reversal of fortunes, global bank shares have surged 8.7% and

energy shares have soared an impressive 19.5% as investors renew old acquaintances with previously unloved parts of the market again.

This has also led to change in fortune for the

UK market versus the US given their very different profiles. While UK equities are up 3.3% year-to-date, the US S&P 500 has wilted -5.1% as popular “growth” stocks have come under pressure.

It is early days, but the shift from expensive growth stocks towards previously unloved parts of the market may have further to run. For investors that might require taking a fresh look

at their relative exposure to relative cheap

UK shares versus expensive US shares, as

well as rebalancing towards sectors that

might prove more resilient in the period ahead.

Banks look particularly interesting after a prolonged period in the wilderness. While higher interest rates are a potential headache for businesses with high borrowings that they may need to refinance, for banks higher rates are manna from heaven. Rising rates create the opportunity for banks to expand the margins they make between the returns they earn investing capital on the money markets and the loans they make to borrowers. If rates rise as the money markets appears to be expecting, UK banks’ profits should soar dramatically over the next couple of years.

Since the global financial crisis many people have eyed the banks with utter contempt for their role in the crisis. But for forward looking investors, it may just be time to let bygones be bygones and learn to love then them once again.

Jason Hollands is managing director at wealth management firm Tilney Smith & Williamson which has offices in Glasgow, Edinburgh

and Aberdeen.