Global equities: Navigating a volatile backdrop

We discuss how our global equity specialists are managing the volatility of today’s market landscape.

Capital markets have certainly had a lot to digest this year: rising interest rates, spiking inflation, slowing economic growth (a striking contrast to the solid economic growth of last year), declining stimulus spending, further global supply-chain disruptions, and geopolitical unrest. All these factors, combined with high valuations, have produced volatile markets. In fact, many major equity markets are approaching bear-market territory, denoting a decline of 20% or more from their most recent peaks.

As Newton’s chief investment officer of equities, I would like to share some perspectives from our firm’s equity specialists on how they are navigating the uncertainty and the fluctuations of today’s market landscape.

Simon Nichols, one of our global equity portfolio managers, offered these thoughts on how to approach this challenging market environment:

1. Don’t panic—the value of a business does not change as quickly as the last share traded. Maintain perspective.

2. An infinite amount of information is dangerous. Ignore the screen. Focus on what, if anything, is likely to change over the medium term.

3. When a conclusion has been reached, be decisive. Don’t be afraid to sell short-term weakness or buy strength when acting with the appropriate time horizon.

4. Maintain focus on what clients expect and what they have asked us to do.

Simon Nichols, portfolio manager, global opportunities team

I recently polled our investment team on what surprised them the most thus far this year, and responses almost unanimously centred on Russia’s invasion of Ukraine. The investment ramifications of the invasion are extensive, and these implications have permeated many of my discussions with our equity portfolio managers. Overall, our investment managers believe that the two most notable areas of consequence are active inflation monitoring and the outlook for global defence spending.

Andy Leger, a portfolio manager on our US small cap team, summed it up well when he said,

We were debating secular deflation two years ago and now we are debating the duration of inflation.

Andrew Leger, portfolio manager, small cap equities team

Inflation figures at the end of 2021 were at some the highest levels we had seen in decades. However, the conflict in Ukraine and associated spike in energy prices have heightened concerns about inflation not only persisting, but potentially persisting at much higher levels than anticipated at the start of 2022.

Inflation is a key macroeconomic variable and a critical driver in determining which world regions and sectors would lead equity markets. So, what is our outlook for inflation? Well, it depends on who you ask. At Newton, our equity team incorporates the inputs of a number of equity research pods, and our investors meet daily, exchanging and challenging ideas as they debate key micro and macro issues. While we are all long-term investors, we also recognise that a rapidly changing backdrop can at times produce nearer-term opportunities, hence the need to be more opportunistic. Thus, we do not have a ‘house view’ on inflation; our individual investors assess the inputs and draw their own conclusions.

Some investors at the firm point to global demographic trends and technology proliferation as being disinflationary, and view inflation as a modest factor looking out over the next two to three years. Others see inflation as a top risk in markets for the next few years, pointing to deglobalisation and an energy-supply situation that borders on a crisis. We all agree that this has been one of the most challenging developments so far in 2022.

An unfortunate by-product of the attack on Ukraine is a recognition by some that defence spending should increase. Paul Markham, head of our global opportunities team, identified that Germany is going to sharply increase its defence spending in a policy shift prompted by the war. He also emphasised that both France and Germany are contemplating changes to environmental, social, and governance (ESG) due-diligence guidelines, which would potentially help defence companies be viewed more favourably through an ESG lens. Furthermore, as the impact of the war in Ukraine could be significant and long-lasting, this could have a major impact on the outlook for defence-related businesses.

So, where do markets go from here? While again, we do not have a ‘house view’ on the equity team, I would characterise the mood as vigilant. John Bailer, deputy head of our equity income team, summed it up well when he said,

We continue to be watchful for changes in momentum, particularly in areas that are economically sensitive and where commodity costs could cause global weakness while creating margin headwinds.

John Bailer, deputy head of equity income, portfolio manager

Our emerging markets team holds a similar view. Paul Birchenough, one of our emerging markets portfolio managers, stated,

We are very conscious of the headwinds for global asset prices over the coming 12 to 24 months. In the face of this, we are opting for more balance in portfolios and a slightly higher allocation to more defensive names and cash.

Paul Birchenough, portfolio manager, global opportunities team

Broadly speaking, we are acutely aware of how robustly equity markets have performed for the last several years. We have clearly entered a new investment era and must adjust to the challenging mix of high inflation and central-bank tightening. While the sell-off in recent weeks has been fast and fierce and investor sentiment has weakened, it may also provide attractive short-term opportunities in equity markets. Our multi-dimensional, active and disciplined investment process remains focused on the big picture, concentrating on long-term structural trends and high-quality companies with solid business models. Additionally, our thematic approach allows us to identify and focus on key elements that we believe could be contributory in shaping the investment backdrop in the coming years.

Authors

John R Porter III

Chief investment officer, head of equity