The macro economy has had to endure several shocks starting by the positive ‘demand shock’ in 2021, followed by the negative ‘supply shock’ since the pandemic and on top of this the war in Ukraine, and the consequent energy shock in 2022. All this has resulted in accelerating inflation going forward. As a reaction to these shocks, Central Banks have a mandate to control inflation and tighten the liquidity conditions. As a consequence the cost of capital is rising. Under this scenario, we do not have to count on Central Banks pulling back from this policy, since they are very determined to fight inflation.
This determination has had a quite fundamental impact on performance, not only on equity markets but also on bonds. Compared to previous corrections, when bonds acted like a cushion, the situation today is very different.
The severe drop in equity returns has made investors move to more conservative companies. The high in interest rates mainly impacted the long duration stocks. The food & beverage industry and sectors that are largely considered ‘defensive’ are doing better than others, such as technology or consumer discretionary. These are considered more cyclical. We observed that growth sectors have sold off heavily. If we look at year to date performances, all sectors are showing negative returns, except for the energy sector.
We have seen a multiple compression. Over the last couple of years, we have witnessed a multiple expansion, thanks to the ‘free or easy money’. Today, this is no longer the case. However, the denominator of the price/earnings ratio has remained stable, which is quite remarkable.
In terms of sectors, this move to safety has been especially pronounced in the technology arena. Investors are more selective with their investments. Over the last two years, any company with an interesting or disruptive business model got the market’s attention. Today, we see that the whole technology sector is coming down. However, at the same time, technology has become dominant in our daily lives and plays a central role in decarbonisation. The world is calling for innovation, and companies are more and more eager to embrace technology to preserve their competitive edge. This is why we cannot ignore the medium and long-term perspective.
We believe it is key to adopt a pragmatic approach to navigate the current situation. This big sell off in tech stocks also offers opportunities. In this sector, there are companies with viable business models, and some of them are worth a closer look. Many interesting stocks have become less expensive, showing greater multiples than in the past. It is precisely in these drawdowns that we should look for opportunities.
Today, growth stocks are still more expensive than five years ago, while value stocks are still much cheaper. In an environment of rising interest rates, value stocks can continue to show outperformance in the short term. However, we believe that durable growth companies with sound financial management will always be interesting no matter the markets. These companies will continue to offer opportunities. It is clearly the way forwards.
