This special edition of Asset Allocator is sponsored by Artemis.
Asset Allocator recently hosted a roundtable event on US equities where we brought together a panel of DFMs to get a sense of how they were feeling.
One thing that was clear is that all eyes and ears continue to be on the Fed as the market anticipates its future moves, and there's one part of the economy that is really giving policy makers the willies.
As it turns out, all is not fair in love and war (and inflation) and during the event, which was sponsored by Artemis, the allocators highlighted the different weights given to parts of the CPI basket and why it matters.
Shelter, including rent, takes up a whopping 33 per cent of US CPI, compared with the 4 per cent taken up by new vehicle sales and the 8 per cent for energy.
This is terrifying for the Fed because, while the prices of cars and fuel can fluctuate, the only way for rent is up, up and away.
And unfortunately for everyone except private landlords, we’re only seeing the transitory pressures push inflation up at the moment.
Some of the structural issues still need to work their way through the system, which could take another 18 months.
One asset allocator highlighted how first inflation was driven by oil prices, then it was used cars, then it was house prices. Whatever comes next will be the biggest factor in deciding what the Fed will do.
But what if a miracle happens and inflation settles next year?
Well, said another allocator, unfortunately even if prices come down to a 1 per cent growth rate per month, we’ve still seen nearly 20 per cent of growth this year, and those prices won’t suddenly fall back to pre-pandemic levels.
Rent, especially, is not likely to come down so those who are not homeowners will be stuck with inflationary pressures for a while.
And the bright side?
Well, there isn't one.
Unfortunately, the allocators were unanimous that the only way out of this pickle was a recession. It did not have to be a long one, but it had to be a recession nonetheless.
It seems like this will come as a shock to a lot of asset allocators’ clients, who according to one roundtable participant, are still asking if they can increase the risk in their portfolios.
The recession at the start of the pandemic happened so quickly, he said, that a lot of people didn’t really notice it, so the inevitable upcoming recession is going to bite.
Asked how this impacted his strategy, Cormac Weldon, manager of the Artemis US Select and Artemis US Smaller Companies funds, said to a large extent it is about trying to unlearn a lot of what was learnt over the past 10, 20, and even 30 years.
"Most investors haven’t experienced high inflation," he said.
"We had all got used to valuing long term assets in a certain way because interest rates and inflation was low.
"That’s not just bitcoin and zero profit tech, that’s everything," he said.
Though when asked about the valuation of value stocks, Weldon said they were not looking all that cheap compared to the rest of the market.
On the other hand, he said, some growth companies were trading at below average valuations, though quite a few were loss-making.
"Will the market have an appetite for high growth loss making companies?" he asked.
"It will have some appetite but it'll be at a lower valuation, and meanwhile let’s see how the business model proves out."
The companies to keep an eye out for are those who have dealt with this kind of inflationary cycle before, so any which have operated in South America, he said.
One example is Coca-Cola, which changed how it dealt with bottlers (moving from a payment volume basis to a revenue basis) to cope with rising inflation.
"The other thing is to think about who genuinely has pricing power, who is less susceptible to cost inflation than others."
So how is Artemis positioned?
"We have lower beta than the market, and we’ve increased the degree of predictability and stability so we’re overweight healthcare and overweight utility," he said.
Another area Artemis has increased its exposure to is software. Weldon mentioned Adobe and Autodesk.
"Autodesk has a great market presence, market share, and the valuation is back down to multiples of not long after the global financial crisis," he said, driven partly by a controversy over them changing the terms of their recurring revenues from a three year to a one year.
The opportunities are there, they’re just idiosyncratic, he said.
Break the (supply) chain
Stories about the massive wave of money being funnelled into ESG investments have taken a backseat this year, one allocator said.
And investors have perhaps been mis-sold the story in terms of 'you can have your cake and eat it' with returns and green credentials.
Weldon emphasised how he was seeing a genuine move to more renewable energy sources from the majority of corporates.
"As an example, one of the utilities we own, NextEra Energy, has gone to JP Morgan with a plan on providing them with completely renewable energy, to satisfy the pressures that JP are under.
"That demand remains real."
Unfortunately there has been a severe interruption in the solar side of things, he added, as a lot of the world’s solar energy capacity is in China.
"It’s a problematic political issue…there was input from factories with questionable human rights records."
"The US initially said anything that has any input from China has to stop, and there have been warnings about a lack of solar capacity being built."
The US has relented, he said, but there was still an awareness around supply chains, especially when it comes to renewable investments.
In terms of the returns, he said it was a difficult investment case due to the range of options in the sustainable sector.
"We’ve got a broad base of utilities which have lots of inputs to the business and not just renewable growth."
Another allocator said there was a bigger premium investing in an oil company that would engage with ESG and benefit from that process.
And the recent geopolitical events in Ukraine have focused attention on what ESG actually means, he said.
Another allocator said he's still hearing about communication issues to the end client, with investors coming in and assuming they don’t have exposure to certain companies.
Therefore you either take a handline exclusion at the very beginning, or you get into a nuanced debate about whether certain individual companies are transitioning to net zero or whether they’re greenwashing.
It seems 2022 persists in giving allocators plenty of difficult choices.