There have recently been encouraging signs from purchasing managers indices and other economic indicators and the view from M&G is that, as the post-Covid recovery enters its next phase of expansion, business investment is likely to be a driving force.
Both in the US and worldwide, the investment manager points to evidence of a strong pick-up in business capital spending. As well as preventing growth stagnation, this factor is also likely to ease inflationary pressures, according to M&G.
Noel O’Halloran, chief investment officer at KBI Global Investors (pictured), also believes that fears of stagnating growth are misplaced. His base case for 2022 is for a year of both above trend economic growth and inflation. He expects both will remain stronger for longer than expected by consensus; but, equally, both are expected to moderate later in 2022.
He argues that a regime change is upon us that started in the fourth quarter of 2021, with a new cycle of meaningful interest rate increases a challenging factor for markets to cope with.
“The market has been in denial for a few months but catching on quickly to this,” O’Halloran says.
He adds: “For investors, a higher cost of capital combined with a tightening of the loose monetary environment that have persisted for many years should certainly have impact on how markets behave. Fundamentals such as earnings and dividends will once again matter and be in the ascendancy, while many of the ‘winners’ of recent years that benefitted from cheap and abundant liquidity should struggle. Highly-valued profitless growth stocks and yesteryear darlings will be challenged.”
Further earnings growth
For corporates, O’Halloran says investors should expect a further year of earnings growth for 2022 and also into 2023. While at a slower pace than the rapid pace of improvement in 2021, he insists it will none-the-less be a positive environment for many corporates and one where they may consider how they deploy their cash toward dividend growth and new capex.
David Stevenson, fund manager and director at Amati Global Investors thinks that purchasing manager index (PMI) measures are currently showing very strong readings for global manufacturing activity, and this fits with recent updates he has had from his portfolio companies, particularly in the area of electronic components.
“This reflects underlying strong demand from an ever-increasing digitisation of industrial and consumer products, as well as a rebound from significant under-investment in capital expenditure in recent years. PMIs for services activity are weaker, and this is a concern given the heavy dependency of the global economy on areas such as consumer spending.”
He adds: “Capital markets are clearly focused on the risks of ‘stagflation’ as inflation accelerates and growth moderates, but we are more of the view that we are currently seeing ‘growthflation’, with sufficient demand in the global economy to absorb a recovering supply capacity post the pandemic lockdown.”
Inflationary tailwinds
Stevenson says there are clearly stress points within supply chains as inventories rebuild, and these have persisted a lot longer than expected, but most of the companies he speaks to are still passing input cost pressures onto customers. This, together with wage inflation and high energy prices, he suggests, means that inflationary tailwinds will remain for now.
“The challenge for company earnings comes when there is a timing mismatch between rising input costs and an ability to pass this through in pricing. This can be because a company doesn’t have sufficient customer leverage in a competitive market, or where price increases are restricted to periodic re-negotiation within contractual terms. There is currently evidence of both factors impacting profit margins across a range of sectors, he argues.
Stevenson believes medium-term prospects for inflation lie much more in the hands of central bank policy decisions and geo-political events. The push towards carbon neutrality could also be inflationary through persistently high energy prices.
“With elevated debt levels around the world, heavy handed monetary tightening could slow global activity into 2023. Whilst this might ease supply chain pressures, that could be offset by China’s continued zero tolerance towards Covid outbreaks, with ongoing port lockdowns. Conflict threats between China and Taiwan, and Russia and Ukraine, are other factors to throw into the global outlook mix.”
Stock picking
All these considerations make top-down predictions for growth especially difficult. Stevenson says the advantage of being a stock picker is that this assessment can be focused at the micro level, involving questions such as:
- – What are the specific growth prospects for company X within its core market(s)?
- – What is the uniqueness of its product or service that would allow it to continue to grow in future in either supportive or tougher economic conditions?
- – Is there an acquisitive element to its growth which augments organic momentum?
“Building up a portfolio from a series of individual company assessments rather than an over-arching macro theme, should add value amidst all the market noise.”
He adds: “This approach also cuts through the growth versus value debate. Targeting individual prospects can result in a broad mix of companies, ranging from those which are economically sensitive to those which enjoy long term structural growth drivers”.
“The final consideration is whether these companies offer growth at a sensible price or not.”
Value vs Growth
Julie Dickson, investment director at Capital says that value vs growth has been an ongoing debate now for a while.
“Dramatic oscillations between both will no doubt continue, and we have seen many instances since the global financial crisis where value has outperformed growth for a month or more. However, none of these have led to a decisive return to value, and it is yet to be seen whether the latest value cycle will persist.”
She argues that rather than trying to position portfolios to be on the right side of a rotation, investors may be better served by searching across both growth and value to find stocks that can deliver reliable capital appreciation and income.
“We believe that major secular changes have contributed to a build-up of risks within the value–growth framework and these suggest that future market developments may involve more than a simple style rotation.”
She concludes: “With value and growth investing becoming more nuanced, it is becoming more difficult to consider growth and value stocks as distinctly different. In navigating this, we believe investors should consider looking within both value and growth universes to select stocks that meet their capital appreciation and income objectives.”
