How should investors be positioning within equities?

At the latest Crestone Investment Forum, held on 22 February 2022, we asked panelists to share their views on the likely path of markets and the global economy in 2022. Key issues focused on the likely persistence of inflation, whether central banks could manage inflation lower without damaging the economic recovery, and when fixed income assets would become attractive.

Our panellists:

• Ben Powell - Chief APAC Strategist, Blackrock
• Steven Watson - Portfolio Manager, Captial Group
• Catherine LeGraw - Asset Allocations Strategist, GMO
• Bill Callanan - Chief Executive Officer, Syzygy Investment Advisory
• Stan Shamu - Senior Portfolio Strategist, Crestone Wealth Management
• Scott Haslem - Chief Investment Officer, Crestone Wealth Management

After benefiting from an extremely favourable stimulatory environment, equity markets now face several headwinds. We discussed how investors should be positioning within equities for the next 12 months, and whether the Russia/Ukraine conflict will likely have a longer-lasting effect on markets. Panellists generally feel that equities remain an attractive proposition. A focus on quality and value were persistent themes during the discussion, as well as the need to broaden exposure beyond the US.

How should investors be positioning within equities for the next 12 months?

LeGraw feels that monetary policy is unlikely to have too much of an impact on corporate investment, but investors should be concerned about asset prices. “Assets, including equities, can face a painful repricing as rates rise.” 

She explained that GMO is focused on quality and value, and investors should be looking at the quality of their assets and how much they pay for them. “Quality assets are strong brands with moats around their businesses and significant pricing power. These give you comfort in an inflationary environment.” 

LeGraw also explained that the assets most vulnerable to repricing are those that are expensive and trading at high multiples today. She also explained that in an inflationary world, Australian investors would benefit from exposure to resource stocks, where there is a natural inflation link. Investors should also consider adding renewables, such as wind, solar and biodiesel. Whilst these have a link to fossil fuel prices, they diversify the portfolio in a different way. 

Although valuation spreads are wide across all regions and sectors, LeGraw feels Europe is priced to win. GMO feels the US is in a very expensive ‘super bubble’, but there is a silver lining, given how wide valuation spreads are within countries and sectors, particularly on a value-growth dimension. While Watson agrees that quality is important, he is cautious about focusing solely on this. 

“There are segments within quality that also deserve attention, such as the re-opening of companies related to travel, as well as energy. Overall, we are in the early days of a significant rotation in the market.” 

Despite the presence of some strong companies in the US, Watson feels it is an expensive market, even on a like-for-like basis within sectors. He sees much greater value outside the US. At a headline level, he feels it is disappointing how weak European returns have been, but that there are still some very good companies to invest in, such as utilities businesses with strong and growing renewables portfolios where you are paying for low debt and double digit price/ earnings multiples. He has stronger conviction in non-US markets, is mildly bearish on the US dollar and feels there are great opportunities in emerging markets that have been neglected over recent years. 

Powell is favourable on equities and explained that BlackRock recently upgraded its strategic view on equities to a ‘maximum bullish’ level for a multi-asset portfolio. He believes the environment will remain very challenging for bonds, with yields more likely to rise than fall. 

“If you’re trying to solve for liabilities, you’ve got to keep up with inflation. Bonds at close to zero are not going to get it done. Investors need to be investing in assets that can give them a chance at achieving portfolio ambitions, which is primarily to fund liabilities.” 

Powell explained that a preference for real assets within equities is one way to achieve this, and that the recent pull-back in markets presents a good opportunity to strategically add to real assets/equities

Callanan feels Europe could be a flow beneficiary, should the US dollar weaken and US indices decline. This scenario could result in the marginal dollar of global flow reverting to those areas that may be at a different form of growth inflection. From a European standpoint, he believes there are some very interesting idiosyncratic stories and explained that Syzygy Investment Advisory is trying to be more targeted in its approach, targeting, for example, Greek banks and large energy restructurings. 

Callanan feels that as we move through the year the rotation from growth to value will continue. He also sees the energy sector as an interesting place to invest, with a host of companies generating free cash flow above 20%, as well as buybacks and high dividends. Pricing, volume and margin are all favourable across the energy supply chain. He feels there is a capital intensity story for the oil service companies unlike anything he has seen in the past decade, where they are benefiting from conventional and unconventional sources, such as renewables. 

“These all present a much better opportunity set than high-growth sectors, where negative or zero rate policy really just allowed science fiction to become science fact for a period of time.”

 In discussing UK equities, Powell feels the main challenge is that the UK economy is mostly unrelated to the FTSE 100 index, and is much more of a play on China stimulus, emerging market growth, and energy prices. Essentially, these are huge global companies disproportionately geared to emerging markets. 

“If you want to get half pregnant with emerging markets, then the FTSE 100 is a good way to go about it. It also has reasonable yield.” 

According to LeGraw, GMO sees the same wide valuation spreads in the UK as elsewhere. However, as it is such a narrow and concentrated market, investors should exercise some caution.

Will the Russia/Ukraine conflict have a longer-lasting effect on Markets?

The speakers shared their views on the Russia/Ukraine conflict. We note that these comments are as at 22 February, prior to Russia’s invasion of Ukraine on 24 February and the subsequent sanctions imposed on Russia. 

LeGraw noted GMO is overweight Russia from an equity perspective. “Russia has a ‘fortress balance sheet’, as well as fiscal and current account surpluses.” 

Watson agrees and added “the bus that knocks you down and kills you probably isn’t the one you see coming down the road”. The Russia/Ukraine conflict is not a surprise to the market, and chances are the market has priced it in more or less adequately. 

Callanan suggested that market pricing perhaps has less to do with the conflict in Ukraine and more to do with a much larger geo-political and geo-economic pivot. The Putin-Xi Jiping relationship could substantially raise the tail risks where you have a different form of multi-polarism developing in global geo-politics. 

“The Chinese are going to be watching very closely what happens in Ukraine vis-à-vis Taiwan, and this raises all sorts of geo-political tail risks in terms of the West’s reaction function. This could have significant ramifications for macro investing.”

The Crestone view:

While we remain constructive on growth, we feel that nearterm uncertainty warrants a neutral equity stance. We continue to look for the opportunity to move overweight equities (potentially in Q2 2022), but in the meantime, we hold underweight positions in US and emerging market equities, offset by overweight positions in both the UK and European equity markets.