Equity markets had a volatile start to the year even before the Ukrainian crisis. Yet, profit reports remain strong but toppish. It is a fact that higher interest rates are putting pressure on valuations, particularly on long-duration assets. The speculative mood of 2020 and 2021 has quickly turned to an exaggerated value approach. Remember that value companies are most often using outdated technologies and may therefore not capture on new businesses once sentiment changes.
U.S. stocks continue to trade at a premium. We expect the market to remain volatile with wider premiums than usual for faster-growing companies. On the back of the present crisis, we continue to like information technology and the energy sector. IT offers the best possible growth opportunity while at the same time most companies do generate free cash flows. So this is, even with a higher degree of volatility, a relative safe trip. On the hand, we are keen on energy companies. During the early stages of the pandemic, oil prices turned negative as demand collapsed. On the back of the offer-demand imbalance, the energy sector’s valuation shrank to a multi-decade low.
With energy prices raising, energy stocks are promptly back with outperformance. This occurs on a much better capital allocation and a true capital allocation discipline. Unlike in the past, energy companies now provide strong cashflows which in turn lead to increased share buybacks and higher dividends.