November 2023
Market Commentary
The Market Cycle
(3 min read)
As mentioned in previous notes, the investment environment might be changing significantly, and we need to adjust and prepare to take advantage of change. Since the global financial crisis (GFC) in 2008, policy makers had been focused on fighting deflation which became a threat to the industrialised world as globalisation and China joining the WTO in 2001, kept downward pressure on consumer prices. Events such as the GFC and the Covid pandemic added to central bank concerns.
The result was that global interest rates remained at close to zero for a very long time. The impact on equity markets has been a dramatic outperformance of growth stocks, companies that have benefitted the most from cheap financing and a low bond yield to discount future earnings. Zero interest rates meant that growth companies commanded a higher valuation leading to stronger share price performance.
The chart below illustrates that the growth component has outperformed the overall market since the zero-interest rate environment started, while ‘value’ stocks which are considered cheap from a valuation perspective, are less sensitive to the interest rate environment as they have strong balance sheets and are perceived as ‘old economy’ businesses, have significantly under-performed the overall market.
KMA’s strategy over this period has been driven by the growth environment and consequently focused on funds that invested in stocks with large capitalisations and growth businesses able to take advantage in the huge advances in technology and spread of globalisation. Over this 15-year period, investors have benefitted significantly from this strategy.
However, we believe that the market environment described above may have run its course as we have entered a different interest rate and central bank regime while inflation becomes the key issue for policy makers. Geopolitics has forced the world to change and secure supply chains. The disinflation the West imported from the East has come to an end, not just because of tensions with China, but because emerging market labour costs have caught up. In a world of ESG investing (Environmental, Social & Governance), cheap labour is not acceptable.
The transition towards zero emissions and conflict around the world are all inflationary and will keep interest rates above levels we have been used to. This in turn will have an impact on how different sectors of the stock market will perform, potentially putting pressure on growth companies with weak balance sheets, although we remain positive for quality growth stocks over the long-term and making cheap valuations in the ‘value’ sector that have strong dividend cover more enticing.
In short, we are starting to shift our focus towards a more balanced emphasis within the equity market and, for the first time in a while, adding some exposure to the bond market as real yields, yields over and above inflation, have returned to positive territory. It was right to be targeting growth in a zero-rate marketplace just as we think it is now right to adjust in anticipation of different market drivers going forward.
Peter Geikie-Cobb | Head of Investment Research
Montgomery Associates
2nd November 2023
