Continuing economic stability and the expected slow pace of the Fed's lowering of interest rates is creating a host of opportunities for investors in both equities and fixed income, according to two Capital Group managers.
Equity portfolio management Caroline Randall, based in London, and fixed-income portfolio manager David Hoag, based in Capital Group’s Los Angeles headquarters, presented their mid-year outlook yesterday, weighing in on inflation, interest rates, and new investment trends.
Randall said her big-picture equity outlook could be summed up in a single word: opportunity.
So much of the gains of the S&P come from a very narrow range of companies, that when the stocks are equal-weighted the index is up just 3%, she said.
“That’s what I mean by opportunity. There’s opportunity here for us to look for the laggards. These laggards tend to be exposed to significant long-term growth themes,” she said, adding that those themes range from retirement needs as people live longer to reshoring themes, healthcare innovation and the energy transition.
“We see interest rates that are probably closer to coming down than not. Inflation’s already beginning to reduce. The consumer is broadly OK. Companies haven’t taken on too much debt,” she said. “So that’s not a bad a set-up, and really is an important opportunity to look outside this very narrow market. And also looking outside the U.S. as well.”
On the fixed-income side, Hoag said the current environment is “pretty good” from an economic perspective, but starting to show some signs of deteriorating.
“Some areas of commercial real estate are starting to show signs of stress. Delinquencies are starting to move up in some areas with respect to loans, and credit card balances are beginning to grow,” he said.
Hoag said how people are experiencing the current economic environment depends on where their asset levels are. Higher-income consumers are doing extremely well, he said, as inflation has a very low impact on their standard of living. Middle-incomers are doing OK, as they’ve got jobs and good prospects for future employment, he said.
It’s those at the lower-income levels who are starting to struggle, he said, largely because they’re still dealing with an inflation their budgets were not able to absorb.
“In the markets, we measure inflation as a year-over-year change in price. If a hamburger was $2 a year ago and now it’s $3, it went up 50%,” he said. “Now if it stays $3 for the next year, inflation is zero for that second year. But lower-income consumers are still experiencing that hamburgers went from $2 to $3. They don’t have the calendar in mind.”
This is why sentiment polls and political polls are still showing people very worried about inflation, he said, and the influence this is having on the Fed can be seen in the way the prediction that 2024 would bring three or four rate cuts has changed.
“My view is that the Fed will probably make a cut in this calendar year. There may be more coming in the next couple of years,” he said. “But I do think this cycle will be a little more extended. And so relatively elevated interest rates for a few years would be my most likely scenario.”
Investments For The Second Half
Randall said there are three kinds of companies that are particularly compelling for investment right now: those with steady modest growth that’s mid-single digits, those that are bond proxies, and those that have been dealing with post-COVID headwinds such as supply chain disruption and are starting to get back to normal.
And there are also three flavors of company she favors: those involved in energy transition, companies that are winners in their category, whatever the category is, and what she calls fallen angels.
“The fallen angels historically had very high stable growth. They also had globally diversified portfolios,” she said. “But as the result of some idiosyncratic events—for example, inflation, political issues or supply chain issues—they have derated.”
Nestle would be one such company, as would Diageo, she said.
And investors this year have been greeted by a surprise: dividends coming out of some of the tech giants for the first time.
Usually the purview of mature industries with slowing growth prospects, dividends are being offered by Meta, Salesforce and Alphabet.
“Committing to a sustainable dividend policy is a really strong message from a management team.” Randall said, adding that there’s are real impact on a company’s valuation when that company commits to a sustainable and growing dividend. “It’s really the clearest signal that management can give about their confidence in the future earnings growth potential of the business.”
With fixed income, Hoag said it’s time to deploy cash and cash-equivalent funds into longer duration assets.
“The problem with a certificate of deposit right now, is when it matures, you’re going to potentially reinvest at a lower rate. And so it’s kind of this stair-step down of your return stream,” he said. “If you take this opportunity to own a little more duration, so actually move out the yield curve and own some longer-dated securities, you will get that nice income stream but also have the potential for capital gains again.”
Another area Hoag said he favors is corporate debt, not least because he’s been impressed by how disciplined companies have been. Oftentimes at this point in a cycle, companies start increasing their leverage by issuing debt to fuel their growth, they said.
“It’s remarkable how disciplined companies have been from a bondholders perspective,” he said. “They’re maintaining a very manageable, healthy level of debt. And with a fairly benign economic forecast, the fundamentals look good for investing in companies.”