Investors have more important concerns this year than inflation or recession, according to Capital Group.
There are 10 investment themes that the portfolio managers at the firm are focusing on for 2023, and not one of them requires hand-wringing over inflation or recession.
Instead, investors should be looking for the catalysts of the next bull market, two of the managers said during a webinar presentation of the firm’s investment picks for the upcoming year.
2022 "was the best year for value equities since 1975,” said equity portfolio manager Jody Jonsson yesterday as she recapped 2022 to give a baseline for 2023. “The spread between growth and value was 24 percentage points. Growth was down 29% and value was down 5%. That’s the widest margin since the Y2K era.”
It was an extraordinary year of extremes in all directions, she continued, and in her view the signaling of a regime change.
“Not just of growth to value, but a real reversal of the investment environment that we’ve seen for the last 40 years,” she said. “In the peak of the bull market we had lots of companies that could thrive while having unprofitable business models. They could still raise cash, they could still raise equity, even though their balance sheets weren’t strong and their business models were questionable. I think we’ve seen the market come to revisit a lot of those.”
Many excesses, like crypto and SPACs, have been wrung out of the market, she concluded, and there seems to be a shift away from the large-cap tech companies and a widening out of the market that supports Capital Group’s focus.
Martin Romo, also an equity portfolio manager, said he also believes there’s a huge transition in the market, in economies and in sectors.
“We’re going from what had been a very binary market, a market that was ‘either/or,’ to a market that’s more balanced, and it’s ‘and,’” he said. “It’s a very target-rich environment. We’re in a world where we have cyclical opportunities and secular opportunities.”
But it’s also a world filled with risks many American investors may not be used to, he said, not just economic risk or inflation, but also political and policy risks.
“There aren’t any more fat pitches. We have to beware, be a little more cautious with the valuations, and be willing to embrace some short-term discomfort for that long-term benefit,” Romo said. “It’s a great time to be an active investor, and it’s more important than ever to be global, and scour the world not just for opportunity but also for risk.”
The 10 investment themes the presenters said they’re focusing on are:
The Dividend Decade: “We’ve tended to talk growth or value, but now we talk about growth and income. It’s an ‘and.’ And those two things are not in contrast, they’re actually in complement,” Romo said.
A third of return comes from dividend income, he continued, which is really easy to forget when one thinks about markets going up and down. “We’ve learned the importance of income as a really foundational element to long-term outcomes and your ability to meet those savings goals we all have,” Romo said.
It’s a good time to look at companies that are “steady Eddy,” such as those in healthcare, medical devices and classic consumer companies such as beverage and tobacco, which don’t grow fast and return a lot of capital to shareholders, he said.
New Growth: Romo said the big growth areas of the past—like advertising, streaming, electric vehicles—have reached maturity, and the incumbents are pushing all other players into a go-big-or-go-home dilemma, he said. They have to decide if there’s enough market and what the competitive dynamics mean.
“It doesn’t necessarily mean that growth is gone, it’s just going to change the character of returns. And in that, there may be some opportunities,” Romo said. “I fundamentally believe the trends around cloud and data will continue. Even though there are concerns cyclically, the secular dynamics will continue.”
Most interestingly, he said, this period feels like Y2K to him, when there was a big surge of investment and the bursting of the tech bubble, but out of that post-burst wasteland emerged Google, Amazon and Netflix. “They took advantage of the infrastructure that had been laid in technology to grow these businesses in a really fundamental way, and I think we may be in a similar environment now,” he said, perhaps with AI leading the way.
Global Champions: These companies can do well in almost any environment, Jonsson said, not least because they have lots of options for ensuring their supply chain.
“If you were dependent on a sole supplier in China during Covid, you had a very difficult time as a company,” she said. “Multinationals are able to capitalize on those kinds of dislocations because they’re used to these sorts of disruptions just because they’ve been global and they’re used to operating in [a] global footprint.”
While we may not feel positively about globalization right now because of the geopolitical situation, she said, the companies that are poised to thrive are those that can move quickly, localize their supply chain and produce closer to where they sell.
“Those companies also tend to be in industries where you have more of a winner-takes-all or winner-takes-most dynamic,” she said. “Companies like Taiwan Semi and ASML in the semiconductor area, and some of the European luxury goods companies like LVMH and Hermès.”
The Golden Age of Healthcare: Companies are on the verge of solving problems like obesity, diabetes, and a little further out, dementia, Jonsson said, and these solutions will be revolutionary in global public health. But when it comes to investment, she doesn’t worry about picking the companies that solve these problems first. She instead focuses on the suppliers of the tools that are needed in the discovery process.
“I can’t predict the absolute winner, but I know that everyone’s going to need the tools, whether it’s the reagents, whether it’s the sequencing, all the things that go into drug discovery,” she said. “I really like that area.”
Industrial Renaissance: Jonsson said the companies that are the obvious leaders in energy, reshoring supply chains or aerospace and defense are recognized by the market, and the stock prices have been bid up accordingly. So here, too, she also likes to look for “tool” providers, whether that means energy security, smart buildings, HVAC and cooling systems that are more energy efficient, or mining for heavy metals for batteries and electric vehicles. “But less obvious than a battery maker or electric vehicle maker,” she said.
These companies have recurring revenues and an increasingly higher service component to the business. Over time, she said, these businesses become less cyclical and more highly valued, ultimately looking more like technology companies.
Reshoring Supply Chains: There are going to be many companies that help build out these new supply chains around the world, Jonsson said. For drug companies, for example, it means having multiple suppliers, whether that’s in contract manufacturing, or fill-and-finish within vaccine manufacturing.
“There’s just a lot of companies helping with this process, like Thermo Fisher, Catalent and Danaher. These are all companies positioned around that drug-discovery chain,” she said. “Also battery sourcing. Many companies had been dependent on China, but they’re now looking more toward the U.S. and elsewhere.”
There’s a theme for every industry, she said.
In addition to these six areas, the portfolio managers are looking strongly at core fixed income and credit investing, selective high-yield investment, and the 60/40 portfolio.