Last financial year, the world’s attention was gripped by Covid statistics, pressures on global supply chains, the differentiated scale of border-reopening across Asia and the West, and estimating the timing and scale of the US Federal Reserve’s monetary policy tightening.
After witnessing a momentum-driven market see-sawing between panic and euphoria over 2020 and 2021, we expected investors to begin renewing their focus on fundamentals and disciplined valuations. We paid close attention to the inflationary dynamics that began to trickle amidst clear signs of global economic recovery and highlighted our expectation of a limited lifespan for the era of free money and abundant liquidity.
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Looking at broader macroeconomic risks for 2022, there was little to suggest that geopolitics would assume centre stage with such immediacy. So, when the crisis in Europe intensified and energy and commodity prices began scaling upwards, speculation about an unexpected stagflation gained ground.
Recently, the large-scale lockdowns in China to tackle the Omicron variant of Covid have only added to market nervousness.
Against this backdrop, momentum-driven areas of global mid-cap equity market, where fundamentals did not support valuations, have significantly de-rated over the last six months. Some of this was, in our view, a necessary valuation readjustment after a few years of risk being priced at inappropriately low levels, while in other cases this presents opportunities as the market shifts its focus to the immediate short-term and loses sight of what could be some of the structural winners of the future.
The other side of these trends are new themes emerging, such as the structural growth of electric vehicles, which is creating significant demand across the value chain in resources, component parts, new materials and semiconductors.
Cyclical recovery is evident in earnings and multiples for the energy, financials and agricultural sectors. Furthermore, reasonably priced, high-quality businesses appear to be relatively strong in a market that is increasingly nervous and uncertain.
Investment portfolios will likely need to stay balanced between long-term growth winners and exposure to the strong economic recovery through energy, resources, industrials, consumer, financials and technology.
The intersection of quality and value is where we think there will be some attractive opportunities. We are still believers that the focus will shift towards the following over the next 12 months:
- Pricing power (given rising input costs, inflation, and potentially increasingly tight labour markets);
- Sustainability and ESG (as society expectations rise, credit costs rise, and competitive pressures intensify);
- Valuation discipline (given there are currently either high or record asset prices in many sectors); and
- What is really driving company growth – is this cyclical or structural?
We believe that it will be less common to see widespread earnings upgrades over the next 12 months if competition for capital and customers intensifies, as it would raise cost pressures and confidence of business to invest increases. However, we would caution that given the rapidly changing macro conditions, a heightened level of volatility may persist for the remainder of 2022. Quality-focused stock picking remains critical led by a strong valuation discipline to find businesses that are positioned to withstand the current multiple macro-economic challenges.
