Can we be sure inflation is now structural rather than transitory and what are the implications if it is still transitory?
Jim Leaviss: I think everybody is in the same boat across the world in not quite knowing how and why the inflation response on the way out of this pandemic has been so strong. It is obviously something more than base effects unwinding. On the inflation price level, we are maybe 4% or 5% higher than we would have been had we not had the pandemic. So there is something else going on as well as the effects of COVID-19. It was maybe triggered by the pandemic, and some longer term supply disruptions continue to be felt – such as car chip shortages leading to surges in second hand car prices.
Another consideration is that over the past 30 years American households have done badly in the battle between capitalism and workers. There came a time during the pandemic where there were huge shortages of labour in certain sectors as society reopened, and a need to re-hire people who had been made redundant or put on furlough. So, suddenly that power base has shifted slightly. Joe Biden had also been elected, expressing strong views that wage rises are a good thing. As we come out of the pandemic, on the whole society has remained relatively open, and there isn’t a reason for this inflation to carry on. There is some element of it that is down to a rebalancing of the relationship between labour and capital, and I think that’s likely to continue for some time to come.
Language from the Fed and BofE is more hawkish than that of the ECB, while rates hikes continue to advance across emerging markets. Is the changing pace of different monetary policies a concern?
Jim Leaviss: There are predictions that the Federal Reserve will hike rates four times this year and again the year after. The Bank of England will probably get towards 1 per cent by the end of the year. Whereas, while there is a chance the ECB will hike by the end of the year, most people expect it to be a 2023 story, with hikes at a much lower level. The core states in the Eurozone have much lower core inflation, and as a result it’s justified that the Eurozone shouldn’t raise rates too early.
I think all central bankers will be asking themselves, “what is the transition mechanism? If we start hiking rates what are we expecting to happen?” There are some areas that are bubbly, such as UK residential property – being stoked higher by very low interest rates. The BofE might decide that arguments are more about getting back to some normality and financial stability than they are about anything that the bank can do to influence growth. I don’t think there is a good argument to try and slow growth to slow inflation, and central banks probably realise that – and that’s especially true of the ECB.
Since the 2008 Global Financial Crisis, growth investing has provided some very strong returns for equity investors. It has predominantly been driven by the US and technology shares. Do you see any other areas of strength in equity markets?
Fabiana Fedeli: Over the last year, we’ve seen a huge concentration in the drivers of equity market performance. For example, in the UK, five stocks contributed to 26% of the FTSE All-Share Index performance in 2021. On the other side of the Atlantic, in the US, five stocks accounted for 30% of the S&P500 Index performance over the same period. This incredible concentration has left a huge dispersion in valuations, and in opportunities. Periods of market volatility throughout the year, in many cases, saw ‘the baby being thrown out with the bathwater’ on the back of indiscriminate, sentiment-driven sell-offs. So there are a lot of neglected ‘babies’ out there in perfectly fine health with attractive growth prospects.
We’ve also seen bifurcation at a regional level. The UK market is now at a 50-year low in relative valuation terms versus the rest of the world. Elsewhere, Japan is looking attractive, with corporate operating profits and earnings per share growth outpacing every major market globally (including the US) over the last decade, but it still hasn’t seen the same valuation boost and appreciation from investors that the US market has seen. Add to that the corporate governance reforms underway, and the greater focus on shareholder returns and balance-sheet efficiency, equity markets in Japan are flagging up some very interesting opportunities.
There are also many opportunities from a sector point of view; we like infrastructure, renewables and climate solutions, along with consumer staples, and we are taking advantage of intra-sector valuation dispersions. In the US, it’s true to say that some IT stocks, underpinned by strong fundamentals, have performed extremely well, but many with weaker fundamentals that have been unable to produce stable earnings have been left behind. This means that the market is increasingly becoming a market for active investors – where fundamental research can come to the fore. It will be crucial to be able to determine which companies are going to be able to deal with the potential challenges we’ve mentioned – inflationary pressure, lingering supply-chain bottlenecks – and can maintain pricing power to defend margins. We’ve been rotating into some of those stocks that have been left behind and, at the same time, where we see that there are strong fundamentals.
