“The outsize returns in cyclical stocks during 2016 primarily reflect their historically unloved and under-owned status at the beginning of the year,” rather than any “rampant optimism” at the end of 2016, Wright said. He urged a more discriminatory approach, citing oil and banks as two sectors he expects to outperform.
While he has some sympathy for sceptical investors given the indiscriminate nature of the rally last year, Wright, who manages Fidelity Special Values and Fidelity Special Situations, said cyclicals should not be dismissed and claimed an earnings recovery across many global cyclicals is on the cards.
“As a generalisation, the stocks I have invested in have been in industries which have seen a reduction in supply and competitive intensity. These are the companies where I see the most potential for returns to improve materially and sustainably. The banking and oil sectors fit this description, but there are other cyclical sectors, such as mining, where I am wary.” Wright said.
He argued some banking models are still positioned to deliver cash flows, and that their 33% re-rating is not an overvaluation and anyone suggesting otherwise would be missing “the historical perspective.” He added Royal Dutch Shell has ‘considerable’ potential to grow and increase dividend payments in time.
The volatility of 2016 should encourage investors to remember the importance of proper diversification rather than discount cyclicals out of hand, Wright said.
He added: “The unforeseen political changes in 2016, alongside reasonable global GDP growth, have presented the first serious challenge to the deeply embedded ‘lower for longer’ interest rates framework. If interest rates have finally stopped falling, this would remove what has been a structural headwind, and create a much more supportive environment for value investing to re-assert itself in the mainstream market, after a long period in the wilderness.
“While I do not expect value investing to outperform in a straight line from here, or necessarily to repeat the dramatic short-term outperformance of last year, 2016 should serve as a reminder to investors that proper diversification means being prepared for multiple macroeconomic scenarios, including inflation, growth and rising rates.”