It certainly feels as if we’re entering a new era for investors, and that can be pretty unsettling, particularly after a year like 2022, where we saw extreme volatility and stock markets around the world declining. But we believe that this is the right time to focus on what the new regime may look like and start to position accordingly. Over the last four decades, investors have really benefited from falling interest rates and low levels of inflation. There’ve been many drivers of that: China’s integration into the world economy, the globalization of supply chains, and let’s not forget, the productivity gains from technology. This frankly lulled many investors—and frankly, some policymakers—into believing that low inflation was here to stay. Yet under the surface, we saw a series of actions, particularly around quantitative easing, that caused pressures to build up in the system.
As we came to the pandemic—and yet again, policymakers around the world responded with further quantitative easing and keeping interest rates at low levels—with the supply chain disruptions that the pandemic brought about, it really triggered the bout of inflation that we started to experience in 2022. I think there are two important implications of this new regime. The first is that there’s a real cost of money going forward, and that’s going to have significant implications for how companies both fund their operations and make investment decisions. On the other hand, there’s going to be challenges around profitability, with inflation clearly putting significant pressures onto the cost structures of many businesses. There’s the direct impact of higher interest rates and higher costs, as inflation is at elevated levels. Moreover, as we see deglobalization and companies have to reshore operations, it’s going to lead to further cost pressures. And let’s not forget the fiscal situation that many companies operate in, with the possibility of higher taxes on corporates around the world.
The good news is active investors can help find companies that can still prosper even in these challenging times, and by identifying those companies and investing in them, we can set up portfolios for success going forward. We believe quality companies can prosper even in challenging environments. By quality, we mean companies that have pricing power, who have a competitive advantage, who are innovating, and who have strong management teams and workforces. Additionally, companies that are exposed to long-term growth drivers have significant advantages, whether that’s around climate change, whether that’s around demographics . . . it gives an additional kicker to growth that’s less dependent on the cyclical short-term nature of the economy. We may be entering an environment of much lower returns for investors, but in that kind of environment, you’re going to need equities to deliver real returns where those returns outpace inflation.
What we find, as we saw in 2022, is equities can struggle in periods of very elevated inflation, but as inflation moderates, we believe that equities can deliver. We know that there’s still going to be uncertainty. Inflation is still at a high level, but we know there’s a lag between when interest rates rise and their impact on the economy. As we look forward, likely inflation will moderate. Another area where we know there’s a lag is around corporate earnings. As we went through last year, corporates, even right up until the end of the year, were telling us things were fine, but we know that those earnings are likely to come down. And as we see that moderation and inflation, as we see that earnings reset, it allows us to start to look for companies and position portfolios for strength going forward. As active investors rooted in fundamental research, we believe that the uncertainty creates a good opportunity to find fundamentally attractive companies at attractive valuations that will prosper in the coming years.