|Invesco CIO Stephanie Butcher|
As we entered 2022, the debate raged on whether systemic inflation was temporary or more permanent. that was Any There is a risk that inflation will return to the system.
As we now know, the temporary view has faded over 2022. Central banks have aggressively hiked interest rates and sovereign and investment grade bond markets have had their worst year ever. Deflation-era winners such as technology and long-term growth stocks came under intense selling pressure, shifting relative equity market leadership to the defensive and value sectors. Energy commodities and stocks soared.
As we enter 2023, the debate shifts to the inevitable fall in inflation from high levels. In the eyes of many commentators, this marks a peak in U.S. interest rates and could be the starting point for the Fed to “pivot” from tightening and into its aggressive risk-on rally. increase.
Inflation is likely to moderate from its current peak levels, but this is different from achieving target inflation. Deflationary and inflationary pressures in the financial system are functions of changes in input costs, labor force, and demand.
China’s deteriorating demographics and growing geopolitical tensions mean its ability to outsource to cheap labor is diminishing. Developed markets are seeing labor shortages due to generational shifts in working patterns, but it is not yet clear how permanent these changes will be.
Meanwhile, the pandemic and the invasion of Ukraine will force fiscal spending to focus on ensuring security in the broadest sense, covering energy supply, defense spending and supply chain resilience. This is likely to accelerate the capital spending cycle, where energy and raw material supplies cannot keep up with demand and become more urgent (partly due to the desire to reduce carbon intensity in response to climate change). cause). This imbalance between supply and demand will only intensify as China gradually unleash of its coronavirus legitimacy.
As a result, we believe the market is right to expect a pause in the rate hike cycle, but we believe there are other structural drivers of inflation in the system, so we should expect a rapid pivot. is cautious.
For 30 years, investors in developed markets have enjoyed the tailwinds on the way from rates above 15% to near zero by early 2022. Justifying the rise in growth equities multiples and historically low yields in the fixed income world (his 30% of global bonds in 2019 had negative yields). Both assets performed very well.
Central banks are now draining liquidity from the system to combat inflation. The days of “free” money are over.
What does all of this mean for us as investors? In the short term, the risk of a recession exists. The multiple has fallen this year as discount rates have increased, but we haven’t yet seen any real weakness in analyst earnings forecasts. The first half of 2023 is likely to be dominated by assessing how much the price will be revised down compared to what has already been set. While the cyclical sector has already fallen significantly, the defensive sector has held up much better despite rising input cost pressures.
In the long term, we anticipate a continued high cost environment. In that context, pricing power is key and the ability of individual management teams to navigate the complexities of a more deglobalized operating environment will be a true differentiator. While the absolute level of debt at the level becomes much more important in assessing risk, cash on the balance sheet begins to become an interest-bearing asset, supporting earnings.
Among other things, risk-free rates now impose a cost of capital. Companies need to be able to prove cash returns, not long-term promises.
Valuations, largely abandoned as interest rates hit the zero bound, are back as a risk factor. With the market dynamics we witnessed in 2022, teams across asset classes recognize the opportunities presented. Fixed income teams are starting to see value returning to the market, but with interest rates rising, careful analysis of credit risk is essential. Our Asia team has seen the Chinese market drop significantly from rising valuations and is now seeing selective opportunities as the market as a whole is trading at his 1998 valuation. increase. The UK and Europe remain unloved by global investors, but have significant exposure to industries that will benefit from changing market dynamics at attractive valuations (this is due to a very challenging macro and political backdrop). nonetheless supported relative performance in 2022).
However, the overarching message from all teams is that relying on market-driven returns (beta) or factors is likely to be less effective than it has been in the last decade. Instead, rigorous analysis of financial and non-financial metrics by working with management to understand corporate strategy and valuation disciplines are key drivers of earnings. For fundamentally oriented active investors, this is a fertile environment.