Higher inflation is regarded as being particularly bad for US equities as that market has substantial exposure to areas such as technology and consumer goods, and fewer in areas such as commodities, which would typically perform better in a world of higher inflation.
But Papesh says that while the US market contains many stocks which may temporarily fall out of favour, there are others which will benefit from the shift in market sentiment.
He says: “We’ve got many investments in the portfolio we expect will be able to do well in a period of higher inflation. Investments in energy, materials, and commodity-related areas of the market are typically viewed as being good hedges on rising prices, and we’ve got decent exposure to a range of investments in each of these areas.
“Across the broader portfolio, we’re focusing on companies that have good 'pricing power', that will be able to pass on some of the higher prices to their end markets. While the near term may be challenging as input costs increase faster than prices, over time many of these companies will be able to increase prices and we’ll see margins rebound. Inflationary fears have put pressure on a lot of companies wrestling with these increasing costs, and we’ve been able to lean into weakness selectively with a longer-term view that margins will expand into 2022 and 2023.
“Financials would be the other big area of the market that should do well in a period of moderately higher inflation.”
Rupert Thompson, chief investment officer at Kingswood says he expects equities generally to struggle this year.
He says: “First, the buy-the-dip mentality which has curtailed any equity correction this year has been fuelled by TINA - the belief that There Is No Alternative - to equities. The outlook may no longer be half as good as it was but still looks better than for bonds, the main alternative for most investors. Prospective equity returns over the coming year are likely to be no more than high single digits at best.
“However, this is still significantly better than the returns on offer from fixed income. 10-year UK gilt yields may have doubled in the last couple of months but are still only 1.2 per cent. If as seems likely, yields continue to trend higher, gilts are set to deliver negative returns.
He adds: “The second factor behind the equity rebound is corporate earnings. The third quarter reporting season has got off to a strong start with the big US banks beating expectations significantly.
“They benefited from the M&A boom boosting investment banking revenues and smaller than expected pandemic-related losses on their loans. The expectation now is that US financials and large cap stocks overall will both see earnings up a touch over 30 per cent on a year earlier. Earnings growth is slowing as a result of the weaker economic backdrop and upward pressure on costs but should still drive further gains in equities in the medium term.”
david.thorpe@ft.com
