Thursday 1st September 2022
Challenges and opportunities exist for long term 'quality' investors
A recession is looking more than likely with the global equities market deteriorating and valuations coming under pressure, says Bell Asset Management.
The outlook for global equities appears to be deteriorating with valuations coming under pressure and the chances of a recession looking more than likely, highlighted Bell Asset Management.
On a recent research visit to the US, portfolio manager Adrian Martuccio met with company management teams to discuss their outlook and business confidence.
“As we look at the state of the US economy, global company management teams exhibited similar viewpoints about the high likelihood of a recession with the vast majority being more sanguine that a slowdown/recession will ease supply chain bottlenecks”, he said.
Martuccio explains that the fact that many businesses believe that supply chain issues are still widespread, primarily labour driven with smaller companies, though these backlogs will likely decline by the end of the year as inventory gets replenished.
“As recession uncertainty continues, sectors such as manufacturing and selective retail are seeing elevated inventory levels becoming the heart of the problem in their businesses, partly due to growing backlogs, long transit times and over-ordering.”
The impact of escalating inflation levels is causing concern after it hit 9.1 per cent in June 2022.
“Employee shortages are rife across the nation and inflation continues to be well anchored compared to last year. While investors adjust their expectations of the inflationary pressures they face, we believe that US household and bank balance sheets remain healthy”, Martuccio said.
“One thing is certain, a combination of soaring inflation, slowing growth and high company margin expectations is taking place, as the hiking of interest rates on equity valuations evolves into investor worries.”
Martuccio explains the fact that company consensus forecasts are still high and must come down. The market has largely factored this in with investors questioning whether company earnings will moderate as both demand and margins come under pressure. It will be challenging for companies to rally convincingly in the face of downgrades.
“From a stock perspective, sharp declines across equity portfolios are putting investors under severe pressure to hold long-term return potential. In our experience, lower volatile portfolios focused on high quality companies with low levels of debt and high cash flow are an essential indicator of ‘Quality’,” Martuccio said.
“They have the potential not only to provide superior risk-adjusted returns, but they may also exhibit defensive characteristics in times of market volatility. We expect that ‘Quality’ as a style will generate material alpha in this current environment.”
Martuccio is confident this trend should continue through the economic slump and in the early stages of the recover. With portfolios remaining fully invested, ‘Quality at a Reasonable Price’ or ‘QARP’ style (investing in high quality businesses while not overpaying for them) will continue to outperform in challenging periods.
Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.
