Within less than 12 months, the world has changed on the back of geopolitical tensions that were previously latent. Regions of conflicts or potential conflicts are numerous, and they all change the previously established order which was the support for globalization. Debates about globalization, energy transition, reshoring, supply chain sustainability, and cyber security are the norm today.
On a comparative basis, we believe that challenges are bigger for DM than for EM. Whatever is undertaken in DM results in a transition from one system to another, and two of the most evident examples are energy transition and digitization.
Next-generation solutions are valuable developments, especially in the area of security. Yet, they all come with an immediate cost, i.e., inflation. That occurs by means of raw materials to build new infrastructures. While these digital services help to gain digital sovereignty, they come with a cost for now. For instance, under the CHIPS and Science Act, foundries are required to onshore which impacts supply chains and intensifies competition for the best locations between players.
Investment ramifications
The events year-to-date have clearly earmarked that industries, and therefore our economic systems, need to be more resilient, therefore less dependent on a single supply chain. Companies mastering this broad-based fundamental approach will allow investors to take a deep dive for quality stocks across industries. These opportunities arise in various areas, i.e., amongst quoted companies as well as among privately held entities. The common denominator amongst these companies is a high exposure to technology to support their rapid evolution. Other opportunities occur in the more capital intensive and public sectors, yet regulation is more often heavy and allows for less rapid progress. As of now, we center our exposure in the US market on the following:
- Defensive, with a focus on fundamental growth
Companies with strong fundamentals are often found in more defensive sectors such as consumer staples, pharmaceuticals, real assets, and aggregate service providers in the field of technology that are less sensitive to changes in the economy or inflation. Companies with strong pricing power may also be able to pass through rising costs and preserve their profit margins. Financials tend to be another value staple as they benefit from rising interests and inflation — yet, this time round, the cycle for financials might be short as lingering private debt may expose them to long foreclosures. - Quality secular growth
In the past, the premium that investors were willing to pay for long-duration growth was well above historic average. Today, on the back of economic uncertainties, the same has moved well below average, though we have not seen a broad-based deterioration in fundamentals!In fact, broad-based value strategies can offer a perfect hedge during periods of inflation and economic uncertainties. Aggregate service providers in the technology sector generate large amount of free cash-flow which makes them a natural hedge against inflation. Investors seeking quality secular growth stocks are advised to seek companies with high gross margins. A stable gross margin indicates a strong pricing power and customer fidelity. Typically, companies having these benefits are related to SaaS, IIoT, Automation, and Robotics.
- Fixed Income
We believe that the interest rate cycle is close to its top. Customers seeking flexibility are recommended to consider floating-rate leveraged debt benefiting from higher income while interest rates are still pointing upwards. One should seek higher quality ratings such as BB/B and plus.Investors seeking longer-term fixed income opportunities are advised to consider US and European investment grade (IG) corporate credit as the outlook still looks promising compared to other markets. Overall, it appears that corporate fundamentals can provide some cushion against shocks to growth or persistently high inflation
IG companies entered 2022 from a position of relative strength, having benefited from the economic reopening in major economies and accommodative financial conditions that allowed debt to be issued or refinanced at low rates. For other markets, we like less cyclically-exposed companies, industries, and sectors. Like the broader market, BBB-rated credit fundamentals are healthy in aggregate and not all BBB-rated companies are small, cyclical, and exposed to decelerating growth. In ME, we particularly like exposure to the Emirates (Dubai/Abu Dhabi), Kuwait, Qatar, Bahrain, and Saudi Arabia since these governments benefit from resources sales at well above average levels.