James Inglis-Jones

Fragile market outlook no obstacle to investment conviction

James Inglis-Jones

The European Central Bank decision earlier this month contained a mixed message; hawkish to the extent that it finally included details of quantitative easing’s (QE) termination at the end of the year, but also including a dovish commitment to hold rates at remarkably low levels for another year at least. Financial commentators achieved a compromise in referring to the announcement as a dovish taper – QE purchases will reduce from 30bn a month to 15bn after September, before finishing in December – but the question remains, what does this mean for investors in European equities?

Sam and I have intentionally constructed an investment process which is almost exclusively bottom-up, which means that we can often get away with side-stepping questions like these. This reluctance to second guess policymakers or make macroeconomic predictions shouldn’t, however, be viewed as an attempt to avoid the big questions. It instead reflects our acceptance and understanding that statistically speaking, these sorts of forecasts are very difficult to get right.

We prefer to deal in objective, empirical observations rather than subjective speculation. This doesn’t mean that we are unwilling to talk about ECB policy for example, but any discussion we enter into will be within a framework of observable behaviours by companies and investors.

It just so happens that the ECB’s latest missive coincided with our annual Cashflow Solution review process, when we engage in forensic analysis of reports and accounts released by European companies. This means we are in fact in a good position to comment on the investment backdrop for European equities. Whilst the process is ‘bottom-up’, we have found that aggregating our data at the market level has some interesting implications for equity investing.

If I were to tell you that one of the conclusions from our analysis has been to label the investment environment as ‘uncertain’, you might not think it a classification that is particularly portentous for investors. Worse, it might seem a weak assessment. However, this uncertain environment could somewhat counterintuitively represent a better backdrop for our process than a bullish market. We have observed a clear pattern in the historical data that the Cashflow Solution process tends to thrive in periods of uncertainty and volatility and we have no reason to suspect that this time it will be any different.

Our determination that the investment environment is ‘uncertain’ rests on observations we make about corporate and investor behaviour. European markets remain in a fragile uptrend and this is usually positive for future returns. However the context of the uptrend is somewhat concerning. Market valuation is high relative to history and there are signs of widespread investor complacency – both conclusions that we draw from our aggregated cash flow data. We have found clear evidence in developed markets that paying attention to investor complacency and valuation in the context of market trend gives a good steer on the likely path of returns over the next 12 months. If the current trend breaks, our data show that the valuation and investor sentiment backdrop today could have troubling implications for future returns.

Sam and I also pay close scrutiny to corporate behaviour – as distinct from investor behaviour – which we are able to infer from a study of our aggregated cash flow data. We find that when there is widespread evidence of complacency among corporate managers it is a usually a sign that equity investors need to think about running for the hills. At this point in time our measures tell us that complacency among corporates is picking up – the trend is concerning and we are monitoring it closely but our indicator has not yet reached levels we would associate with a bleak equity market outlook.

Although we now face market conditions which look increasingly fragile, the good news is that an uncertain market environment does not imply poor prospects for our investment process. Quite the opposite. We would much rather invest in weak or neutral market conditions where fundamentals are asserting themselves on valuations than in a rampantly bullish market where gains are indiscriminate.

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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Investment in Funds managed by the Cashflow Solution team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Liontrust European Growth Fund holds a concentrated portfolio of stocks, if the price of one of these stocks should move significantly, this may have a notable effect on the value of the respective portfolio. The Liontrust Global Income Fund's expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation.


This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, June 25, 2018, 10:52 AM