Continuing economic stability and the expected slowdown in the Fed’s interest rate cuts have created a host of opportunities for investors in both equities and fixed income, according to two managers at the firm Capital Group.
Equity portfolio manager Caroline Randall, based in London, and fixed-income portfolio manager David Hoag, based in the firm’s Los Angeles headquarters, presented their midyear outlook in June, weighing in on inflation, interest rates and new investment trends.
Randall noted that many of the S&P 500’s gains have come from a narrow range of companies, and that when stocks are weighted equally the index is up just 3%. She said that this presents an opportunity for investors to seek out the laggard stocks, which will benefit from such trends as increased consumption from people living longer, as well as healthcare innovations and the energy transition.
“These laggards tend to be exposed to [those] significant long-term growth themes,” she said.
“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 setup, and really is an important opportunity to look outside this very narrow market.”
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. But those at lower levels are struggling to deal with the inflation that 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.”
While inflation has come down, it hasn’t come down as much as Fed Chairman Jerome Powell would like, and in response he’s signaled just one rate cut this year, not three.
“I do think this cycle will be a little more extended,” Hoag said. “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 in the mid-single digits; those that are bond proxies (companies whose stocks go up when rates go down); and those companies starting to get back to normal after dealing with post-Covid problems such as supply-chain disruption.
She favors three flavors of company: those involved in the energy transition; those that are winners in their own categories (whichever they are); and those she calls “fallen angels”—companies whose historically high growth rates have been derailed by some recent trouble such as inflation, political problems or supply-chain issues. Such supply hiccups have hurt food and drink companies such as Nestlé and Diageo, for example.
She said investors this year have also enjoyed a surprise: dividends coming out of some of the tech giants like Meta, Salesforce and Alphabet for the first time. Usually dividends are more likely to come from mature industries with slowing growth prospects.
“Committing to a sustainable dividend policy is a really strong message from a management team,” Randall said. “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 on 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. Oftentimes at this point in a cycle, companies start increasing their leverage by issuing debt to fuel their growth.
“It’s remarkable how disciplined companies have been from a bond holder’s perspective,” he said. “They’re maintaining a very manageable, healthy level of debt.”