Stubborn inflation and long-term uncertainties are setting the stage for a potential shift in growth and value equity market leadership. Of all the aspects of regime change, the impact stemming from the breakdown in the 30-year downtrend in interest rates resonates with Newton portfolio manager Andy Leger the most.
Over the last year and a half, the switch to a rising interest rate environment has impacted growth and long duration assets, says Leger. “Shorter duration, more value-focused, free-cash flowing assets have done a bit better.”
Another area of interest to Leger is private equity.
“For the past 20 years, private equity has been able to raise unlimited amounts of money with ever increasing amounts of leverage with few covenants,” explains Leger. “The question going forward is how many more of these companies can we finance with negative cash flows? And, will there be more of a shift of some of the funds back to small cap?”
Leger adds, “I think what we do know is going forward, there is going to be more of a premium in small cap attached to lower leverage on the balance sheet and more of an advantage for some of these small cap companies or strategic buyers of assets.”
Potential opportunities in emerging markets
Emerging market equities may be at an inflection point, according to Newton portfolio manager Ian Smith. Geopolitical tensions and the rising call for energy transition is putting emerging markets in the spotlight.
He says: “The reason why emerging markets is the center of that is because the majority of the emissions in the world today are derived from emerging markets. By far, the most exciting long-term opportunity is trying to understand where companies can provide tech-based solutions and where the solutions can be really impactful in emerging markets.”
Smith predicts certain areas of production will be localized in China while supply chains will diversify to places like India.
Not all doom and gloom
There is a positive dimension to regime change, according to John Bailer. “You want to focus on those high cash-flow generating businesses that have great balance sheets,” he says.
A prime example of such a business sector would be the advertising agency industry.
“If you look back over the last number of years, the companies that were spending a lot of the advertising dollars were those companies that were benefiting from “free” money (in this low interest rate environment),” notes Bailer. “They took their IPO (initial public offering) money and put it back into digital advertising to enable them to grow very, very quickly.”
However, Bailer notes that these are not the customers of the big advertising agencies.
“Advertising agency customer bases are more exposed to the slower growing Procter and Gamble’s, Coca Cola's of the world,” explains Bailer. “It looked like these agencies were losing share and these stocks were valued like they were secularly challenged.”
He adds: “I think there is a great opportunity to get into these more traditional advertising agency names. By the end of last year, they've been able to outgrow the big digital advertising companies while their customers have strong pricing power.”
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