“Large-cap defensives have been in play for quite some time, explained Tony Yousefian, consultant at Albemarle Street Partners. “They are now at best fair-value and at worst over-valued, and are susceptible to underperformance.”
Meera Hearnden, senior investment manager at Parmenion Investment Management, added: “Defensive companies have become very popular and valuations have gone up over the years, so there is more potential for earnings disappointment.”
So, with large pockets of the FTSE 100 ruled out, where should investors be looking?
No room at the top
“At this point in the economic cycle managers should be looking for plays on recovery, and early cyclicals should be quite a nice place to be,” said Yousefian.
“Funnily enough, you would not have thought banks would be a recovery stock, but they look a good way of playing the market. Typical growth-orientated stockpickers are the way forward over the next 18 months, and there are plenty of opportunities in the mid-FTSE 250 down.”
Peter Lowman, chief investment officer at Investment Quorum, believes that in this sort of market environment the best opportunities lie in so-called ‘recovery’ funds – funds that target companies that are undervalued by the market.
“We are finding the pockets of value coming from undervalued companies and restructuring plays,” he expanded.
“If you are uncertain over what is going to happen then it is better to be in cheaper assets, because if we get a bit of hammering over the summer then the more expensive companies are probably going to fall the furthest.
“We have an overweight in the medium and high-risk portfolios to these small and mid-cap recovery stories through the Schroder Recovery and Miton UK Value Opportunities funds.”
However, Hearnden argues that the current economic environment is not conducive to such an approach, given the potential for downside on earnings expectations, and investors are better off waiting to make a more timely entry.