The past 20 years have been characterised by falling interest rates and inflation, as well as low volatility around GDP.
In addition, investors became accustomed to the Federal Reserve put at the first sign of asset price turbulence.
However, we are now in a fundamentally different regime, as the Fed and other central banks tighten policy in response to rising inflation.
Our base case remains stagflation, and far greater volatility in nominal GDP growth outcomes to what we have become used to in recent years.
In the next slowdown, we anticipate a continued shift towards fiscal activism, rather than the passive outsourcing of economic policy to central banks via quantitative easing and asset price stimulus witnessed during recent decades.
We expect this stimulus to focus on long-term investment areas like decarbonisation, tech and infrastructure, as well as efforts to localise supply chains.
Against a backdrop of stagflation, investors need to be selective, as growth and value will become more correlated, and bonds and equities will continue to be correlated.
A weak economic environment is challenging for weak cyclicals, just as much as high inflation is challenging for weak growth stocks.
Equity markets will likely become more stock-specific rather than driven by style, and tightening credit conditions will see the market continue to favour resilient businesses with strong balance sheets.
Uncertainty brings opportunity
We see several such businesses in the enterprise software space, which has seen a widespread drawdown in valuations over the recent months.
We believe larger market leaders in the space are well-placed to outcompete many of the single-feature companies, where high-growth rates will deteriorate rapidly in a more testing economic environment.
Enterprise resource planning, or ERP, refers to software solutions for the finance department – such as general ledger, accounts receivables, and payables management, and procurement.
These solutions exist to improve back-office and logistics productivity, while cloud versions further enhance expense savings and business agility.
Resilience amid inflation
Away from the software space, there are some pharmaceutical companies – another type of quality defensive businesses – that are not facing the same inflation pressures as other defensive parts of the market.
These are companies that have significant earnings that come from vaccines and animal health, which have high barriers to entry, consolidated market structures and, as a result, higher profitability relative to traditional drug development.
Jacob Mitchell is chief investment officer at Antipodes Partners
