Securities Trust of Scotland (STS ) has seen its portfolio of quality growth stocks underperform in the New Year rally, prompting Troy fund manager James Harries to warn the ‘remarkable ebullience’ cannot last.

In January the £217m investment trust saw net asset value (NAV) slip 0.5% and its shares drop 4.9% against the 2.7% average advance of global equity income funds tracked by Lipper.

That’s left the trust on a small 2.5% discount to NAV per share and with an 11% three-year total return that lags the 27% average of the small band of rivals it competes with on the London Stock Exchange.  

Harries, who took over the listed fund in November 2020, said last month was noteworthy for the strong rebound in cryptocurrencies, meme stocks and expensive growth stocks such as Tesla that had slumped in 2022.

In dollar terms, bitcoin soared 39%, AMC Entertainment, the cinema chain once beloved of Reddit investors, leapt 31%, while Tesla’s 41% gain was outshone by Carvana, the secondhand car marketplace which accelerated 215% after attracting the support of legendary investor George Soros.

Harries, who prefers to hold large, financially stable stocks such as British American Tobacco (BATS), Paychex (PAYX.O) and Unilever (ULVR) at the top of his portfolio, said a ‘steep countertrend ascent led by previous market darlings’ was a feature of declining markets and a reminder that old habits die hard.

Harris believed investors were mistakenly hopeful that peaking inflation would see central banks become less hawkish and slow down the pace of interest rate rises and return markets to a ‘Goldilocks’ world where they were ‘neither too hot nor too cold’ for equities.

‘This will likely turn out to be optimistic,’ Harries said. ‘It seems more likely to us that we are in a passing phase between inflation beginning to ameliorate, implying more supportive policy settings, and the likely upcoming recession which could negatively impact earnings growth.’

As evidence, he pointed to the inverted yields on US government bonds with shorter-term two-year Treasuries offering 4.66% after the Federal Reserve’s rapid rate rises last year. By contrast, longer-term, 10-year Treasuries yielded less at 3.9%, indicating an economic downturn and lower interest rates were expected.

He warned that what looks like a reprieve may ‘turn out to be a brief interlude and make the short, sharp, repricing of risk look premature’.

Harries’s comments came this week before new PMI data in the US showed an unexpected recovery in business activity, undoing hopes that inflation was coming under control and the Fed funds rate would soon peak. Markets fell yesterday and today in response.

Analysts at JP Morgan have also become more cautious with Mislav Matejka, head of global and European equity strategy, this week saying the first quarter rally had gone too far and that the Fed would only ‘pivot’ on rate rises once it was clear the economy was suffering.

‘Historically, equities do not typically bottom before the Fed is advanced with cutting, and we never saw a low before the Fed has even stopped hiking,’ Matejka said.

‘It might be premature to believe that recession is off the table now, when Fed will have done 500 basis points [5%] of [rate] tightening in a year, and the impact of monetary policy tended to be felt with a lag on the real economy, of as much as one to two years,’ Matejka explained. ‘The damage has been done, and the fallout is likely still ahead of us.’