'When it comes to portfolio construction, 'boring' can be good'

A period of strong economic growth was propelled by the convergence of various technologies; robotics, artificial intelligence, 5G and the internet of things drove a surge in growth.

This resulted in significant inflation, prompting central banks, including the US Federal Reserve, to tighten policy and aggressively raise interest rates. This was exacerbated by supply-side disruptions (Ukraine), and an overheating economy contributed to the end of the roaring twenties notion.

Today, economies are broadly back to pre-pandemic state. Real output is close to the trend of the past 10 years. Growth rates between the years leading up to the pandemic and the current post-recovery period are comparable.

It’s as if the pandemic has left us not far from where we started. If you had fallen asleep in 2019 only to wake up today, economically not much would have changed, other than interest rates and the effects of inflation. 

Factors such as debt, demographics, and technological advancements are persistent contributors to low inflation – a concern predating the pandemic.

Let’s remind ourselves leading up to the pandemic the concern was that inflation was too low and growth too rare. By the eve of the pandemic in late 2019, the Fed had cut rates three times that year (by 0.75 per cent).

In this boring economy, characterised by stable growth, low volatility, and low inflation, there are benefits for equity markets.

Now we return to the 'boring economy' of the 2010s, one marked by low economic growth, low volatility and low inflation, albeit not so low as to drive unemployment higher. The overall objective – to maintain low and stable inflation – is on track.

As discussed, the drivers of low inflation in the 2010s such as high debt, aging populations, and technological advancements still persist. 

In this boring economy, characterised by stable growth, low volatility, and low inflation, there are benefits for equity markets.

Low volatility is conducive to employment, bringing workers into the workforce, aiding much needed long-term skills development. It also facilitates better business planning and investment. 

Short-term interest rates may outpace forward rates through to at least mid-2024. 'Higher for longer' is the mantra. But the signalling further out is a positive for equities: falling rates.

There's an interesting contrast between the stability of the P/E ratio on the S&P 500 during the 2010s and the current economic situation. It underscores the idea that there are opportunities in markets even in a seemingly boring economy.

Stable P/E ratios or company valuations contribute to investor confidence. Investors are more likely to be attracted to markets where valuations are consistent and not subject to wild fluctuations. 

The drivers of low inflation in the 2010s such as high debt, aging populations, and technological advancements still persist. 

A stable P/E ratio serves as a benchmark for valuation. Investors can compare current P/E ratios with historical averages to gauge whether a stock or the market in general is overvalued, undervalued, or fairly valued. This gives disciplined stock-pickers plenty of opportunity. 

Investors who prioritise dividend yields find stability in P/E ratios advantageous. A stable P/E ratio can indicate a consistent relationship between stock prices and dividends, making it easier for income-focused investors to plan for cash flows.

In summary, a stable market P/E ratio provides investors with a sense of security, predictability and confidence, and reduces or eliminates the need to chase the more exotic opportunities that may present themselves from time to time.

Mark Clubb is executive chairman at Team Asset Management