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At the risk of sounding like we have fallen prey to economic hype, we believe this economic cycle is very different from recent cycles. High inflation is the common thread running through the economic growth outlook and almost all asset class performance this year. The last time the US experienced stagflation was in the 1970s, when most of today’s investors were not even involved in the market. Many investors don’t know how to invest in this environment. Indeed, we are now in a period of profound global change. It may be time for investors to evaluate what they have done in their portfolio during the last 10 years and then do the opposite.
We see opportunity in some of the unique market dynamics occurring right now that we haven’t observed in decades: cash is doing better than bonds year to date, value stocks are beating growth stocks, international equities are trumping domestic equities and commodities are the runaway winner. Inflation and rising rates are the common theme running through them all.
We believe the notable divergence in the performance of value stocks and growth stocks deserves some explanation. High inflation is forcing central banks to respond with very aggressive tightening, which in turn leads to higher rates. Higher rates create competition for capital both in the markets and for businesses and consumers. Most consumers must now carefully consider where they spend their money, and we believe these decisions come down to “needs” vs. “wants.” “Needs” are increasingly trouncing “wants.” Food, shelter, clothing, car fuel, education and healthcare are compulsory for many consumers. Companies operating in the sectors that provide people’s necessities are generally faring better than sectors that offer people’s “wants,” such as Consumer Discretionary, Information Technology and Communication Services. And thus, we believe value stocks are more inviting than growth stocks right now.
The New York Fed provides us with a very telling outlook on how “needs” and “wants” are expected to affect consumers’ spending (see Figure 1).
Valuations also support the rise of value stocks. Higher interest rates force investors to strongly consider the price they are willing to pay for stocks and cheaper stocks are performing better than growth stocks, which have traditionally carried rich valuations. The value vs. growth dynamic is playing out globally and it just so happens that the composition of international equity markets is more skewed to value stocks than growth stocks and international equities trade at cheaper valuations than domestic equities, enhancing their appeal.
Right now, there is also a strong case for owning commodity- related investments as a hedge against inflationary pressures. The increased geopolitical risks stemming from Russia’s invasion of Ukraine combined with the imbalance between supply and demand are likely to continue to support commodities.
We believe these trends will persist. Once the inflation genie is out of the bottle, it’s very difficult to put it back. In our view, supply chains will eventually fix themselves and a growth slowdown will curb demand so inflation won’t remain at current elevated levels, but it could settle in above the 1-2% range we saw after the Global Financial Crisis due to tight labor markets, de-globalization and a commodity super cycle.
At Schroders we are betting on value stocks, international equities and commodities. To learn more about our view, please contact your Schroders representative.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.
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