March 2022 – Top-Down View
The first 2 months of the year have painted a mixed picture for investors, with global geopolitical concerns coloring the overall investment environment. To begin with, let’s examine the fundamentals that we expect will come back into focus once the Ukrainian crisis abates.
As we head into the 3rd year of economic recovery, central policy is expected to shift towards reducing global liquidity and managing the inflation outlook. However, given the unprecedented conditions, central banks will struggle to find equilibrium. On one hand, if the liquidity reduction and the interest rates hiking occur too swiftly, the economy will slow down, resulting in job losses, a reduction in discretionary spending, increased loan defaults, and so on. On the other hand, if interest rates are not adjusted and liquidity is kept high, cheap and abundant funding will allow consumers to continue to spend while prices continue to increase over a given period of time. At the moment, this scenario seems quite distant as the market has a well-developed sense of what is good over the long term.
As we head towards the 2nd quarter, the tightening financial conditions may get delayed and the performance of risk-on assets may surprise, especially for long-duration stocks as fourth quarter earnings reports were outstanding overall. Although some headlines have featured a few earnings misses, the overall earnings outlook is good, and the corporate world is healthier than it was back in 2020.
Areas of Opportunity
Despite lower expected returns for 2022, there are openings for all types of investors. Let’s drill down into the most valuable opportunities in the market:
- US Value Stocks: Although we continue to favor growth stories related to secular growth trends in the field of Next-Gen Connectivity, global value stocks offer a reasonable short-term opportunity. On the back of a prolonged period of higher-than-expected inflation, these companies could potentially offer value buckets providing outperformance for a given period of time.
- U.S. Growth Stocks: Well-established mega-cap technology stocks have underperformed the broad market year-to-day. Currently, many of these technology companies – most of which are cash-rich and can endure a prolonged period of lower-than-expected revenues streams – are trading at attractive valuations. The most valuable opportunities are related to companies operating in the field of connected devices—from electric vehicles to smart-home devices and medical monitoring systems. All these enablers are still grappling with a shortage of semiconductor chips—a deficit expected to extend well into 2023. As a result, the pricing power will be relatively high.
- Europe: It is true that European stocks are cheaper, and most have a strong value bias. Pending geopolitical developments, European equity markets may continue to remain cheap. Long-term investors may consider engaging with companies in the energy and materials sectors, which should be oncoming disrupted demand-offer conditions.
- Asia ex-Japan: Because Asian governments have greater involvement in directing prices of prime products than elsewhere, inflation is perceived differently. In addition, consumer spending is still somewhat limited because of ongoing Covid restrictions. However, on the positive side, supply chain disruption is less of an issue in Asia than in Europe or the United States. While the broader region has underperformed the global market by about 30% since 2016, we nevertheless believe that Asian markets are currently a suitable opportunity for assets that don’t need to be invested in Europe or in the US.
- Credit: In the coming weeks, geopolitics are likely to impact credit spreads, but we do not expect this to last for a prolonged period of time. This occurs on the back of a largely positive credit momentum, reflecting favorable financing conditions and a powerful economic recovery. Longer-term credit risks include persistently high inflation and market volatility, which would undermine a regular market evolution, particularly for the more leveraged corporates and some emerging markets.
- Consumer-Spending: Until now, the generation of consumers between 35 and 54 years of age did most of their spending on discretionary items such as apparel and travel. However, this consumer spending behavior is expected to shift, as millennials tend to have different priorities.
For example, experiential spending such as travel, apartment refurbishment, and healthy living are expected to stand out on the back of highly efficient e-commerce and direct-to-consumer channels. Despite inflationary trends, targeted investment opportunities appear valid given above average sales growth and above EPS appreciation these economic activities.
The bottom line: At this time, we do not have a strong view on the Russia/Ukraine situation as it relates to the equity markets. However, we believe that much of the bad news has already been priced in at this point, and that the market has made the correction sell-off. Therefore, we would consider re-entering the market at this time.
Thanks for reading and for sharing our detailed views!