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Digital Darwinism Is at a Disruptive Tipping Point for Investors

eugene-zhyvchik-xJY-7gtC38o-unsplash — Pixabay CC0 Public Domain. El darwinismo digital está en un punto de inflexión disruptivo para los inversores

Internet connectivity and digital tools have transformed everything from retailing to how we watch movies, learn, order food, and experience healthcare, forcing countless companies across industries and sectors to evolve to new digital realities or risk extinction in an ongoing process that has come to be known as Digital Darwinism.

Now, this trend is at a tipping point that will make the disruption of the past two decades seem like table stakes, with myriad implications for investors

Today, software and hardware advances coupled with artificial intelligence (AI) have accelerated to such an extent that technology is creating unprecedented opportunities for innovation, impact and disruption across countries and economic sectors. This global phenomenon will sweep some businesses aside, allow others to gain dominant market share and impact the world’s geopolitical order. It’s also an opportunity for investors to profit from disruption and to contribute to positive real-world change.

This survival of the “digitally fittest” exposes weaknesses in firms lacking technological prowess while enabling others—sometimes small firms—to dominate. While Digital Darwinism to date has been most prominent in the consumer sector, now it is permeating everything in a moment of exponential growth, bringing society ever closer to what Ray Kurzweil calls Singularity, the moment where the power of man and machine converge.

The evolution is evidenced by the shortening life cycle of companies: The longevity of an S&P500-listed company was 30-35 years in the 1970s but is expected to shrink to 15-20 years during this decade, according to Huron Consulting.

Amid this paradigm shift, three trends to which investors should pay particular mind stand out:

Data and connectivity

Three decades ago, few people had Internet access, now 60% of people are online, accelerating disruption by generating 2.5 quintillion bytes of data daily. That data is being used to improve goods and services. The Internet of Things (IoT) highlights the pace of change, growing 9% in 2021 alone to 12.3 billion connections. More and more of the global economy is now digital: Within the MSCI All Country World Index, digital firms generated about $7.4 trillion of revenue in 2020 versus $2.2 trillion in 2001. That number is forecast to reach as much as $30 trillion by 2040, creating opportunities in everything from the metaverse to networking, connectivity infrastructure, semiconductors, cloud storage and cybersecurity.

Man-and-machine

This concept starts with the notion that the human body is hardware and DNA its software code. For example, the speed, innovation and collaboration that led to the rapid development of COVID-19 vaccines suggests scientists and technologists can meaningfully advance how we deal with all manner of diseases. Nanotechnology scientists are installing microelectrodes to help the blind see. Beyond health, the man-and-machine age holds vast potential too. As the metaverse blurs the lines between physical and digital experiences (spurred by Internet connectivity, virtual reality and the blockchain) shopping, entertainment, culture, and payments will be revolutionized. Imagine standing in your renovated kitchen before construction begins or test-driving a car at home. In education, students can be immersed in a culture or place. Imagine learning about the pyramids in Egypt by “visiting” one in the metaverse. Media, too, will change inexorably. Today in the US, consumers engage with 11 billion days of digital content annually and watch another 14 billion annual days of TV.

Climate tech

Addressing climate change is our biggest challenge today but it creates opportunities for investors to support positive change. In the year to June 2021, $87.5 billion was invested in firms combating the climate crisis, up from $24.8 billion the year before, according to PwC. As more capital is spent on the transition, significant investment will flow to technology innovators. US climate change envoy John Kerry forecasts that half of the cuts needed to achieve net-zero emissions will “come from technologies we don’t yet have.” Investors can support everything from AI-powered marketplaces for carbon offsets to improved power infrastructure.

All this could shake up the geopolitical world order as leading economies such as the US and China use technology to vie for dominance in the vital industries of the future, from making solar panels to semiconductors and robotics. As all this shakes out, there will be volatility as certain countries gain marginal power and advantages in particular sectors. On balance, however, I would expect to see the formation over time of stable global alliances that will facilitate disruption without onerous volatility.

These trends are challenging traditional equity investing approaches, as they too, after all, are not immune to Digital Darwinism. In this light, the evolutionary approach to buying stocks looks set to be thematic in nature, where investors can allocate capital via such themes as AI, the metaverse, clean-tech, healthy living, food security or water, instead of strictly based on industries, sectors or regions. This process could also help allocate capital more efficiently during the transition to a more sustainable world by allowing portfolios to invest for impact, both contributing to solutions while potentially benefitting from the volatility caused by the inevitable disruption.

A column by Virginie Maisonneuve, Global Chief Investment Officer Equity at Allianz Global Investors

ESG in Practice Series: Stéphane Rüegg on Credit

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RUEGG-Stephane-DSC_0889-2100x1402-7a34cf1f-2f9d-4e5e-8009-cc9ba5fad3dd — Pixabay CC0 Public DomainStéphane Rüegg, Pictet Asset Management. Stéphane Rüegg, Pictet Asset Management

Credit expert Stéphane Rüegg at Pictet Asset Management discusses what’s on the mind of his clients, the nascent green bond market and his very personal view of responsible investing.

Why does investing sustainably matter to you?

My awareness came about in different ways. First of all, watching the Rio Summit as a teenager, I vividly remember Brazilian indigenous leader Chief Raoni talking about the preservation of the Amazon forest. Also, I am a history buff and it occurred to me that lots of battles in military history would have had very different outcomes with climate change. The French were victorious at Austerlitz because the lake was frozen and they fired cannonballs that broke the ice; that lake has now dried up. A harsh winter during the battle of Teruel in the Spanish Civil War saw temperatures drop to minus 20 – nowadays they climb to 10 degrees in January. One contributing factor to the French Revolution was the poor harvest of 1788 which caused food shortages and high prices. These examples abound. Finally, I have lived in Asia and there are very few places where you can drink tap water, except perhaps Japan and Singapore. People drink from plastic bottles, which are not recycled. These different thoughts have made me reflect about the environment.

Even within Europe, there are some clear cultural distinctions around ESG

What are clients asking about?

Up until a few years ago, governance was the main ESG factor that influenced investments, and the environment mattered less because of the misalignment that former Bank of England governor Mark Carney calls ‘the tragedy of the horizon’: investment managers are judged on their 3-year track record while the impact of climate change will only be apparent in the coming decades.

However, with extreme weather events there has been a welcome realization that we are in a climate emergency. It has become a higher priority in Europe; Asian investors are looking at these developments and asking a lot of questions. Overall, clients’ main concern is ultimately driven by regulation. In Europe, we are moving towards a shared green taxonomy, but we will have to see how investors use it in the long run. It should not just be about hitting a threshold; we also need data that allows to track the progress of a company over the long term.

New standards will be gradually rolled out in Europe but even within the region, there are some clear cultural distinctions around ESG. German clients do not like nuclear power while others, like the French, think it’s necessary to make the transition to clean energy. In Belgium, home to many large brewers, the green label does not exclude alcohol.

Often, awareness about climate is the result of an environmental disaster, like Fukushima in Japan. In the US, the BP oil spill in the Gulf of Mexico helped change attitudes among American investors. The increased frequency of hurricanes and a spell of intense cold in Texas at the beginning of the year have intensified concerns about the environment across the US.

What risks investors in green fixed income should be aware of?

If I told you, imagine a bond with a social objective that allows people with little money to enter the property market and to integrate into society better, would you invest? Well, imagine it’s 2008 and I have just repackaged subprimes to you as a way to help American society reduce its fractures. So you have to be careful not to be dazzled by the green.

It’s a nascent market that requires you to have some major principles to guide your investments, like the moral compass that guides your personal life. You need to analyse the instrument as much as the issuer and follow up closely to ensure the company delivers on its promise. We are spoiled at Pictet because as a rule, we have what we think is the best supplier for each aspect of E, S and G – at the end of the day you need the data to understand ESG.

A broad-brush approach to evaluating companies’ ESG performance does not work, it is crucial to understand the dynamics of each sector. The environment is key for mining companies, for example, but the social aspect is equally important, in terms of accidents and working with local communities. A case in point is mining company Vale in Brazil where a lethal dam disaster caused the company to lose its position as the world’s largest iron ore extractor and sparked a governance and safety review. The way a company sets prices, or it treats customers or suppliers is just as important as the environment.

Are green ETFs an easy option for fixed income investors?

Green bonds ETF allow investors to dip a toe in the water, but they simply replicate an index. Bond index managers only include issuers that meet their eligibility criteria, so depending on data availability bonds may not be eligible for inclusion for a few months after issuance. When a company doesn’t report properly, it can take months to exclude the bond from the index.

And then it comes down to whether you agree with the benchmark. Do you include green bonds from companies that pollute? Do you include a green bond from an airport operator? When you buy an ETF you leave these decisions to the index provider. We think these are very important conversations to have with our clients.

It would be wrong to think that green bonds are the only way to gain exposure to virtuous companies. Companies in the business of blood testing or those in the health sector do not necessarily issue green bonds yet their contributions to society are important. Some companies may be ‘green’ but do not issue green bonds, such as this US water technology company we have in the portfolio. We bought the bonds because we were interested in the strategy of the company. Then they issued a green bond. On the other hand, we’ve had the example of an energy company promoting its sustainability credentials, then buying a shale gas company when the US energy market collapsed.

Does ESG change the job of professional investors?

In our team we have always cultivated a long-term mindset. Technological change and regulation are key inputs in our process because they can create new risks and opportunities and trigger a mini credit cycle in a sector. So, when ESG regulation started to come into force, we were not taken by surprise.

We also always have had a very fundamental investment approach of asking ourselves “why is the company making this acquisition/changing its business model by launching new products – does it make sense?” We may be opportunistic from time to time, but our approach is that we lend money to a company; we’re not traders.

We also talk to companies about our concerns. You can challenge company management during the meetings that you have with them, you don’t necessarily need defined engagements. Ultimately, governance is very important. You can’t trust a company on its environmental commitments if it doesn’t have good governance.

It would be wrong to think that green bonds are the only way to gain exposure to virtuous companies

Is the new generation more ESG-conscious?

I am not of the opinion that millenials believe in ESG much more than others. I think that each generation has its own biases and its blind spots. In the time of my grandparents, the harmfulness of tobacco was not taken into account at all. Today’s young people don’t understand the link between their streaming habits and the exponential growth of carbon emissions. Our ancestors saved water, used up all leftovers. Today we are in a much more wasteful society. My children don’t recycle. They have a sincerity about them, but they have blind spots, like all generations!

To read more about investing sustainably at Pictet Asset Management, click here to access the Responsible investment report.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation.

The information and data presented in this document are not to be considered as an offer or sollicitation to buy, sell or subscribe to any securities or financial instruments or services.

Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management (Europe) SA, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management (USA) Corp (“Pictet AM USA Corp”) is responsible for effecting solicitation in the United States to promote the portfolio management services of Pictet Asset Management Limited (“Pictet AM Ltd”), Pictet Asset Management (Singapore) Pte Ltd (“PAM S”) and Pictet Asset Management SA (“Pictet AM SA”). Pictet AM (USA) Corp is registered as an SEC Investment Adviser and its activities are conducted in full compliance with SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref.17CFR275.206(4)-3.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in Canada to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Manager authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA

Pictet Asset Management: Buying the Dip

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It’s been a gloomy start to the new year. Economic growth has disappointed, Covid cases have spiked and stocks and bonds have sold off sharply. But we believe the world economy and equity markets might be through the worst – at least for the short term.

Following January’s rout, we believe that global equities can return around 15 per cent by year-end, thanks largely to a 13 per cent rise in corporate earnings and a steady trickle of dividends. Global bonds, meanwhile, look likely to deliver capital losses.

Taking advantage of attractive valuations, we have chosen to upgrade equities to overweight. This is a tactical move, conditional on the speed of US monetary tightening and on a successful resolution of the crisis in Ukraine. Reassuringly, our multi-asset risk appetite indicator – which measures the extent to which the market has been rewarding or penalising historical volatility – remains in positive territory, in contrast to past market corrections.

Even though recent economic data has been mixed at best, our business cycle indicators suggest the recovery remains intact. Although have reduced our forecast for global growth in 2022 to 4.4 per cent from 4.8 per cent, that projection is still above the 4.2 per cent consensus estimate. (1)

The negative impact from the Omicron Covid variant should largely be contained to the first quarter of this year and we continue to believe that a return to more normal economic conditions should be the theme for this year – service sectors should reopen and recover to pre-pandemic levels of activity, supply chain constraints should ease and, crucially, price pressures should peak early in the year.

In the US, we expect inflation to crest in March, which should offer some reassurance to financial assets by reducing the risk of excessive tightening from the US Federal Reserve. Delivery times are shortening and purchasing manager surveys are pointing in the direction of disinflation.

Elsewhere, we see more grounds for optimism in China, where a broad-based recovery is now evident across all sectors. While our leading indicator is still in negative territory, momentum has improved. The reacceleration in fixed asset investment is particularly strong, especially in manufacturing, and infrastructure spending is picking up as well. Credit conditions are improving, too, and policymakers remain willing to respond to growth concerns.

While markets are discounting the prospect of sharp tightening of monetary policy worldwide, our liquidity indicators paint a more balanced picture.

Clearly, our readings have felt the impact of the Fed, which has turned incrementally more hawkish; one FOMC member suggested the central bank could hike rates by 50 basis points in March. The market has already priced in more than four rate hikes for the year. However, there remains uncertainty around the timing, pace and data dependency of quantitative tightening and indeed around the impact it will have on assets.

We are looking at a potential ‘quadruple tightening’ in the US: an exit from quantitative easing (QE), rate hikes, the start of (QT) and real tightening as inflation recedes. Our liquidity models suggest that the cumulative effect of these moves may result in a 4.5-5 percentage point increase in the US “shadow” real policy rate – which is adjusted for QE and QT policy moves – this year alone (3). To put that in context, the tightening in 2014-19 was 6 percentage points.

But that tightening is offset by easier conditions elsewhere.

In the private sector, for example, the flow of credit is accelerating and has now reached 10.2 per cent of GDP on a global basis (2).

Furthermore, even as some central banks are tightening policy, China continues to move firmly in the other direction. Since December, Chinese authorities have announced a 50 basis point cut in the reserve requirement ratio (RRR), a reduction in lending rates for small and medium-sized enterprises and rural loans and, crucially, a 10 basis point cut in policy rates and a cut in loan reference rates. The rhetoric from various policymakers appears synchronised, pointing towards further easing.

We will be watching closely, potentially on standby to return to a more cautious stance on equities later in the year if needed. For now, though, global liquidity conditions are broadly neutral for risk assets.

Our valuation indicators show that equities as a whole look relatively attractive, exhibiting the best valuation score on our scorecard since March and trading close to fair value. Given the approximate 20 per cent decline in MSCI ACWI’s price-earnings ratios since September 2020 (from 20.7 to 16.7 the pre-pandemic level) our models now suggest no further contraction in earnings multiples till year-end.

Among sectors, materials and healthcare stocks look particularly attractively valued and even tech is no longer excessively expensive. Chinese equities are well positioned to make up for some of the steep underperformance seen in 2021. China is currently one of the cheapest equity regions, according to our models.

Valuation scores have also improved across fixed income, too.

Technical indicators show poor seasonality trends for bonds; bond funds have seen only muted inflows since the start of the year. In contrast, equity funds have seen inflows of some USD67 billion, despite the recent sell-off. Notably, flows into Chinese stocks have accelerated, chiming in with our more positive stance on its stock market.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Notes:

(1) Bloomberg consensus forecast for 2022, as of 22.01.2022.

(2) Private liquidity flow calculated as bank & non-bank net credit creation over preceding 6 months, as % of nominal GDP, using current-USD GDP weights.

(3) Real policy rate calculations use Wu-Xia Shadow Rate (2016) methodology for QE/QT adjustment.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation.

The information and data presented in this document are not to be considered as an offer or sollicitation to buy, sell or subscribe to any securities or financial instruments or services.

Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management (Europe) SA, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management (USA) Corp (“Pictet AM USA Corp”) is responsible for effecting solicitation in the United States to promote the portfolio management services of Pictet Asset Management Limited (“Pictet AM Ltd”), Pictet Asset Management (Singapore) Pte Ltd (“PAM S”) and Pictet Asset Management SA (“Pictet AM SA”). Pictet AM (USA) Corp is registered as an SEC Investment Adviser and its activities are conducted in full compliance with SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref.17CFR275.206(4)-3.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in Canada to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Manager authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA.

Pictet Asset Management: Omicron Wave Won’t Sink Stocks

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A new year, old problems? The rapidly spreading Omicron variant has triggered renewed mobility restrictions, leaving investors concerned about the economic fallout in some parts of the world.

But the global recovery remains resilient, thanks to a strong labour market, pent-up demand for services and healthy corporate balance sheets. Ample household savings can also cushion the blow: the IMF forecasts that the global gross savings ratio will hit an all-time high of 28 per cent in 2022.

Weighing the Omicron threat against this economic picture, we leave our asset allocation unchanged for the time being, with a neutral stance on equities and an underweight position in bonds. Given our positive outlook for the economy, we are looking for opportunities to raise our weighting in stocks in 2022.

Our business cycle indicators show the global economy is on track to grow 4.8 per cent in 2022.

We raised our GDP forecast for the US as the world’s biggest economy is experiencing a strong recovery in both manufacturing and services.

Buoyant consumer sentiment and excess savings of some USD2.2 trillion should also lead to robust jobs growth in the coming months.

Price pressures, however, been stronger and more persistent than expected. November CPI rose at the fastest pace since 1982 at 6.8 per cent, with core inflation running at an above-trend 4.9 per cent.

Even after stripping out Covid-sensitive items and base effects, inflation is still running way above the central bank’s official target at 3.6 per cent.

We expect core inflation to peak at 5.8 per cent in early 2022, which should prompt the US Federal Reserve to raise interest rates by as early as June 2022; it recently announced its intention to end asset purchases by March.

The euro zone economy remains resilient, but the outlook is becoming less clear because of the economic impact from renewed mobility restrictions and persistent supply chain disruptions.

Nevertheless, we still expect the region’s economy to grow 4.4 per cent, higher than the market consensus. We have become more optimistic on Japan; its economy is recovering from a sharp but brief Covid wave.

The country’s vaccine rollout is progressing well while consumer and business confidence indicators and housing market data have been encouraging. A weaker yen and a fresh fiscal stimulus should support growth in the coming months.

Our liquidity indicators lend weight to our neutral stance on equities.

Liquidity conditions for the US are turning negative as the Fed moves to rein in a surge inflation with tighter monetary policy. The picture is very different in China after the People’s Bank of China cut its reserve requirements ratio by 50 basis points in December.

The latest PBOC easing should release about RMB1.2 trillion of long-term monetary stimulus according to our calculations, equivalent to 1 per cent of GDP. The PBOC is creating liquidity at a quarterly rate of USD232 billion, by far the fastest pace among all major central banks.

Our valuation signals are more favourable than a year ago for both equities and bonds: price-earnings multiples for world stocks are down some 10 per cent from this time last year while bond yields across developed economies have risen by as much as 50 basis points.

Even so, it is difficult to find good value in any major asset class. We expect equities’ price-earnings ratios to contract some 5-10 per cent again this year in response to rising real bond yields.

Our expectations for earnings growth this year stand at 16 per cent, however, more than double the market’s consensus.

Technical indicators have turned negative for equities due to seasonal factors.

Balanced against this is the fact that investors sentiment is much less bullish than a few months ago, suggesting some more upside for riskier assets.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation.

The information and data presented in this document are not to be considered as an offer or sollicitation to buy, sell or subscribe to any securities or financial instruments or services.

Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management (Europe) SA, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management (USA) Corp (“Pictet AM USA Corp”) is responsible for effecting solicitation in the United States to promote the portfolio management services of Pictet Asset Management Limited (“Pictet AM Ltd”), Pictet Asset Management (Singapore) Pte Ltd (“PAM S”) and Pictet Asset Management SA (“Pictet AM SA”). Pictet AM (USA) Corp is registered as an SEC Investment Adviser and its activities are conducted in full compliance with SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref.17CFR275.206(4)-3.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in Canada to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In Canada Pictet AM Inc is registered as Portfolio Manager authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA.

Outlook 2022: New Capital Asia Future Leaders Fund

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city-ge42080e67_640 — Pixabay CC0 Public DomainCity of Ho Chi Min, Vietnam. Ho Chi Min

The key theme across Asia continues to be digitalization, supported by an increase in IPOs across e-commerce, mobility, and FinTech. Chris Chan, Portfolio Manager of the New Capital Asia Future Leaders Fund, shares his thoughts for 2022 for the Asian equity sector.

2021 was a tough year for Asian markets Compared to the S&P500, Asian markets underperformed by about 30% (year-to-date – 16/12/21). The key element driving this underperformance was the Chinese stock market. However, going into 2022, we are much more constructive on the Chinese market.

There are a three key reasons for this. First and foremost: valuations. If you look at Chinese valuations compared to the rest of Asia and the US markets, historically speaking, it remains very attractive.

Secondly, in December 2021, the PBOC came out for very supportive for monetary easing. When you look back, typically there is a very strong correlation between the monetary easing cycle and Chinese stock market returns. Therefore, we expect this to be a positive stimulus for the China markets for 2022.

Thirdly, when you look at what’s driven the drawdown, it’s largely Chinese Internet names due to the pressures of negative regulation. When you look over the past few months, you can see that the incremental regulatory news flow is much less than it was. We expect this to continue and believe will act as a catalyst for the large cap Chinese tech names to recover.

We do expect bottom up earnings to remain weak, particularly in the property and the consumer sectors, at least for Q1 so we are looking at Q2 onwards for recovery on the fundamental side.

Outside China, we remain constructive on India with valuations historically high given the fact that the market has rallied about 30% (YTD 16/12/21). In the ASEAN region, we’ve been increasing our weight in markets like Vietnam and Indonesia, primarily because when you look at the latent recovery coming out of lockdown, arguably ASEAN has been further behind the rest of Asia, and therefore has more to offer for 2022, as confirmed by superior real GDP growth rates compared to the rest of the region.

The overriding thematic that we see across Asia continues to be digitalization, both in terms of digital services in India and Southeast Asia, supported by the increase in tech or digital IPOs across e-commerce, mobility, and FinTech. Within China, electric vehicles and solar energy remain the key structural trends benefiting a variety of companies across the supply chain.

You can also listen to Chris Chan, Portfolio Manager of the New Capital Asia Future Leaders Fund, rated five stars by Morningstar, as he shares his thoughts for 2022 for the Asian equity sector in this video.

The Strongest Year On Record For M&A

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usa-g07a63680c_640 — Pixabay CC0 Public DomainEl año más alcista para el M&A. Toro

2021 was a great year for the U.S stock market and economy. Stocks were up for the month, 4^th quarter and year and posted their biggest three year gain since 1999. The strength of the S&P 500’s rally is reflected in its 70 record-high closes during the year, second only to 77 in 1995 back to 1928. The U.S. economy staged a strong recovery as rising demand offset supply chain and microchip disruptions, rising prices, labor shortages, and the drag of mutating COVID-19 infections on the services industries. More economic reopening’s, the consumer wealth effect, and inventory rebuilds bode well for 2022.

The above consensus jump in the core U.S. inflation rate took the FOMC by surprise and pushed the 10-year U.S. Treasury note yield up 60 basis points on the year to 1.51%, the most since 2013, when the yield rose 127 basis points to 3.03%. On May 22, 2013 Fed Chair Bernanke announced the start of a reduction of its quantitative easing bond buying and sparked the bond market’s ‘taper tantrum.’.

Chinese President Xi Jinping focused on the need to keep a “strategic focus” in his 2022 New Year address: “We must always keep a long-term perspective, remain mindful of potential risks, maintain strategic focus and determination, and ‘attain the broad and great while addressing the delicate and minute’.”

M&A activity remained vibrant in the fourth quarter of 2021, totaling $1.5 trillion, the sixth consecutive quarter that M&A exceeded $1 trillion and the second largest quarter ever. The strong fourth quarter brought full year M&A activity to $5.9 trillion, the strongest year on record and an increase of 64% compared to 2020 levels. Excluding SPAC acquisitions, which totaled $600 billion, or 10% of activity, 2021 M&A activity totaled $5.3 trillion, still the strongest year for mergers on record. We believe the drivers remain in place for continued robust deal activity in 2022 and beyond.

2021 proved to be a somewhat lackluster year for convertibles globally. After record performance over the past few years, convertibles finally took a breather, resetting valuations and terms. While new issuance continued to be strong this year, some of it was at unattractive terms. Those large issues that came with no coupons and premiums in excess of 50% tended to underperform and drag the market with it. Finally, convertibles have traditionally been favored by growing companies and the rotation from growth to value played a role. With rising interest rates, growth valuations started to seem a bit excessive and while convertibles outperformed their underlying equities as they moved lower, performance relative to the broader equity markets was disappointing.

Looking forward, we are optimistic for our market this year. First, 2021 was a bit of a reset. The market rejected some of the excessive terms and with growth valuations coming back down to earth, we are starting to see some attractive values amongst the carnage. While rising rates may force some growth valuations lower still, they set the table for more attractive issuance in the future. Rising rates have traditionally been good for the market, with convertibles moving higher each of the last 10 times we have seen a 100 bps increase in 10 year treasuries. While there may be more interest rate sensitivity this year, the majority of the market will still be driven by underlying equities.

______________________________________

To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:

GAMCO MERGER ARBITRAGE

GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.

Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.

Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.

Our objectives are to compound and preserve wealth over time, while remaining non-correlated to the broad global markets. We created our first dedicated merger fund 32 years ago. Since then, our merger performance has grown client assets at an annualized rate of approximately 10.7% gross and 7.6% net since 1985. Today, we manage assets on behalf of institutional and high net worth clients globally in a variety of fund structures and mandates.

Class I USD – LU0687944552
Class I EUR – LU0687944396
Class A USD – LU0687943745
Class A EUR – LU0687943661
Class R USD – LU1453360825
Class R EUR – LU1453361476

GAMCO ALL CAP VALUE

The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.

GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise. The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach: free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.

Class I USD – LU1216601648
Class I EUR – LU1216601564
Class A USD – LU1216600913
Class A EUR – LU1216600673
Class R USD – LU1453359900
Class R EUR – LU1453360155

GAMCO CONVERTIBLE SECURITIES

GAMCO Convertible Securities’ objective is to seek to provide current income as well as long term capital appreciation through a total return strategy by investing in a diversified portfolio of global convertible securities.

The Fund leverages the firm’s history of investing in dedicated convertible security portfolios since 1979.

The fund invests in convertible securities, as well as other instruments that have economic characteristics similar to such securities, across global markets (but the fund will not invest in contingent convertible notes). The fund may invest in securities of any market capitalization or credit quality, including up to 100% in below investment grade or unrated securities, and may from time to time invest a significant amount of its assets in securities of smaller companies. Convertible securities may include any suitable convertible instruments such as convertible bonds, convertible notes or convertible preference shares.

By actively managing the fund and investing in convertible securities, the investment manager seeks the opportunity to participate in the capital appreciation of underlying stocks, while at the same time relying on the fixed income aspect of the convertible securities to provide current income and reduced price volatility, which can limit the risk of loss in a down equity market.

Class I USD LU2264533006

Class I EUR LU2264532966

Class A USD LU2264532701

Class A EUR LU2264532610

Class R USD LU2264533345

Class R EUR LU2264533261

Class F USD LU2264533691

Class F EUR LU2264533428

Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to ﬁnd out what those restrictions are and observe them.

Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reﬂect the manager’s current view of future events, economic developments and ﬁnancial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.

Central Banks Facing a Dilemma

| For Beatriz Zúñiga | 0 Comentarios

black-3509513_1920 — Pixabay CC0 Public Domain. Los bancos centrales se enfrentan a un dilema

Inflation at a level not seen for a long time makes it possible: the topic monetary policy tightening has moved onto the agenda again. In the US, the Fed has begun reducing securities purchases – so-called “tapering”. And in some emerging markets, as well as in Norway, New Zealand and South Korea, key interest rates have already been raised. The European Central Bank (ECB), on the other hand, is being coy and hesitant. However, the markets do not really believe that the ECB will stand still for a longer period of time.

Will monetary policy gradually become more “normal” again – in the sense of balanced, with interest rate reactions upwards as well as downwards? Or is it more likely that, after tentative attempts at tightening, the first signs of displeasure from shareholders and stakeholders will lead central bank to reverse the monetary-policy course again?

Unfortunately, the latter is to be feared. The reason is the foreseeable costs and braking effects of higher interest rates. On the one hand, monetary tightening and the associated rise in real interest rates entail the risk of an unintentionally severe economic slowdown. On the other hand, this could have a massive impact on the financial markets: There, the long-standing central bank actions have seriously interfered with pricing mechanisms, overriding them in large parts of the bond market and leading to misallocations and overheating tendencies via the portfolio channel. Withdrawal of the drug “cheap money” therefore threatens turbulence. And last but not least: Global debt, which is getting out of hand, would no longer be financeable “for free”; fiscal woes would dominate.

Not so long ago, central bankers would probably have said “so what?” in view of such risks and acted within their focused mandate to maintain price stability. In the meantime, however, the regime has changed. Sustained action is therefore less likely: monetary watchdogs are unlikely to be prepared to face these consequences.

In an exchange of traditional behavioural patterns, the principle of reverse authoritativeness has now become established for the relationship between monetary policy and financial markets. Central banks are increasingly responding to the signals and needs of the capital markets rather than the other way round. The result is an asymmetrical policy: rapid and significant interest rate cuts, but only very hesitant and small interest rate increases, if at all.

How could it have come to this? The seeds for this development were sown with the worldwide deregulation and liberalisation of financial markets in the 1980s and 1990s. There is scientific evidence that this led to the birth and subsequent decoupling of the financial-market cycle from the business cycle. What is more, it is now clear that the former even dominates and lives about twice as long as the latter. Moreover, history teaches us that deep recessions and sustained deflationary scenarios result – if at all – from the bursting of asset bubbles.

If one wants to pinpoint the starting point of the change of heart to a specific date, the Fed’s reaction to the 1987 stock market crash can be considered a fall from grace. That was the first time that the central bank explicitly responded to falling stock prices. Wall Street later created a new term for this: the “Greenspan Put”. However, financial dominance really took off after the great financial crisis of 2008. Since then, the reaction pattern has been perfected. In this context, the ECB adopted the PFFC regime: “preserve favourable financing conditions”. And since the middle of this year the euro central bank has been regularly publishing a Survey of Monetary Analysts (SMA), in which it asks market participants for detailed information on when they expect the ECB to take which action. This feeds the suspicion of who is a cook and who is a waiter these days!

Against this backdrop and with a view to the question posed at the outset as to whether monetary policy will return to “normal”, the central banks thus find themselves in a dilemma. At present, no real departure from the aggressively relaxed approach that has been in place for years is to be expected. And this despite the formation of bubbles and sentiment-related exaggerations in sub-markets. Just think of the almost 70% weighting of US equities in the global index, real estate markets, cryptos, SPACs (Special Purpose Acquisition Companies) or meme phenomena.

For investors, this has three implications: First, more than ever, diversification is of utmost importance for any forward-looking investment strategy. Secondly, the same applies to agile active portfolio management, which includes a dynamic risk strategy. Both requirements may seem old-fashioned to investors, but they remain imperative. Thirdly and finally, income strategies are advisable in view of the low interest-rate environment that is likely to persist for a long time to come. In equities, these can be implemented by focusing on dividends, for example.

Ultimately, this triad is certainly primarily a reminder of traditional, conservative investment principles. However, monetary policy is currently upside down – keywords: financial dominance and the fight for rather than against inflation. Not to mention the Modern Monetary Theory (MMT). Its ultimate consequence would be the loss of central banks’ institutional independence, which would be deeply regrettable. In view of this threatening backdrop, the aforementioned reconsideration seems very suitable for at least putting one’s own capital investment on a solid footing.

Column by Ingo Mainert, CIO Multi Asset Europe at Allianz Global Investors

Unearthing Asia’s Next Winners

| For Cecilia Prieto | 0 Comentarios

japan-g97e2985aa_640 — Pixabay CC0 Public DomainLíderes del futuro en Asia. Asia

Backing a sector winner is a logical strategy but identifying its heirs is a more challenging alpha generator. Detailed analysis of stock return profiles shows that companies improving their return on equity (RoE) to amongst the top quartile tend to outperform in the long term.

Selecting these businesses involves identifying certain characteristics, but even if they are found, the maturity of the sector in which the company operates is an important factor.

In more maturing ‘new economy’ areas, such as e-commerce in China, it may make more sense to identify the players that are taking market share from the incumbent.

But in more emerging industries, such as electric vehicle components, often it proves more fruitful to back the industry leader because of the inherent uncertainty during the early stages of fast-moving, burgeoning sectors.

Incumbent errors

Leaders in more established sectors can be hampered by several pitfalls, such as losing their focus, and engaging in so-called ‘di-worse-ification’ – whereby they try, often unsuccessfully, to enter adjacent or new sectors.

Even though dominant players often benefit from a first-mover advantage in their infancy, as their sector ages, it becomes more segregated, with new niches emerging, providing opportunities for new rivals to pick off these areas as their own. An example of this is the current China ecommerce incumbent whose dominant market share has been significantly eroded in the past few years due to emerging competitors.

This is why we focus especially hard on particular attributes to help us identify the next upcoming winners within our concentrated 40-50 stock Asia Future Leaders fund, which over three years has delivered nearly three times its benchmark, the MSCI AC Asia ex-Japan index. The fund has been awarded with a 5 star rating by Morningstar.

Innovation focus

The core of our strategy relies on three pillars: quality management, scalability and innovation, with the latter a clear differentiator to traditional investment frameworks.

We harness the deep experience of our Future Leaders panel, which benefits from the experience of a range of prominent professors, including French business school INSEAD’s Nathan Furr, a pre-eminent voice on innovation, to help us identify tangible traits that are often indicators of inventive companies.

Combining the panel’s insight with our proprietary research allows us to pinpoint innovative companies at an earlier stage in their life.

As these companies grow older, we continually assess their competitive edge, which is re-evaluated frequently to see if aspects such as its forward-looking corporate culture and ability to enter new markets remains.

Analyzing the extent to which companies prioritize R&D, and incentivize innovation, are two key metrics we study.

Key characteristics

A common denominator of an innovative company is a decentralized organization that gives middle management meaningful responsibility and rewards them for their success.

One such Chinese materials company compensates its R&D team with 15% of the profits of successful new products and 30% of increased revenue from process improvements.

Another important element is how the R&D side of a business is driven. Firms that rely solely on senior management for their inspiration can often begin to struggle, whereas ones that actively engage with their customers for feedback to influence their R&D are much more likely to prosper.

And beyond this, the ability to gather, process and react to data will drive the winning firms of the future.

Accelerating away

It’s this skill in harnessing data, through the likes of machine learning and artificial intelligence, that has influenced some of our holdings. One such stock is a Chinese electric battery (EV) maker, which harnesses AI and machine learning to apply the latest technology to its production process. The company is a leader in an emerging industry, and its focus and success in R&D is a key attraction for us.

Similarly, another stock we own is a leading China EV manufacturer that has managed the recent supply chain shocks better than peers, in large part due to their superior vertical integration, producing their own batteries and power transistors – two key components of an electric vehicle.

These two companies play into a broader theme of China winning the EV race, especially given its market is already four times larger than the US, there are eight times as many charging points in China than America, and much of the world’s lithium is in China.

This makes us optimistic for these companies as we enter 2022; however, there are other sectors and other countries that we’re bullish on.

Emerging opportunities

The prospects for real GDP growth in the likes of India, Indonesia and Vietnam appear stronger for 2022. In India, we see the potential for huge opportunities, with the pipeline of IPOs doubling in the past year. The pace of innovation in India is remarkable, and it now has the third most unicorns – a private company valued over $1billion USD – in the world.

The pandemic has forced many people in southeast Asia towards e-commerce and other digital services, most first-time users, which means that the opportunity for companies to access a new, larger audience is potentially huge.

EFG Asset Management (EFGAM) is an international provider of actively managed investment products and services to financial intermediaries and institutional investors around the world.

EFGAM’s New Capital funds and strategies offer a focused range of actively managed, specialist strategies across equity, fixed income, alternative and multi-asset within both developed and emerging markets. The strategies are available in a variety of structures including AIFs, CITs, SMAs and UCITS, and are available through vehicles domiciled in Ireland, Luxembourg, Switzerland, Hong Kong and the United States.

Overall Morningstar rating as of 12/31/2021 rated against 730 (O Inc) Asia ex Japan funds on a risk-adjusted basis’.

EFGAM manages approximately USD 32.9 billion (as of December 2021) on behalf of clients.

For professional investors / trade press only. Not to be used with or distributed to retail clients.

Past performance is not indicative of future results. The opinions herein are those EFGAM as of the date of this article and are subject to change at any time due to market or economic conditions.

Boom in Global Private Equity Investments by AFOREs

| For Gabriela Huerta | 0 Comentarios

Captura de pantalla 2022-01-12 095627 — Foto: PXhere CC0. Photo:

In 2021, there were 37 issuances of private equity funds or feeder funds on the stock market (BMV and BIVA), of which 30 were for global private equity investments (CERPIs) and 7 for local investments (CKDs). Of the 30 new CERPIs, more than half are subseries that allow the manager to have a series per SIEFORE and thus satisfy the investment objective at the term of each of the generational SIEFOREs.

The issuance of CKDs and CERPIs observed in 2021 were almost double those that arose the previous year in both cases, however, the number of new CKDs issuances fell compared to what was observed between 2015 and 2018 (14-20 vs. 7 in 2021).

Two years ago (in December 2019), the number of SIEFOREs increased from 5 to 10 SIEFOREs, which allowed for the migration to Generational Funds or Target Date Funds (SIEFOREs based on retirement age).

Over time, some CERPI issuers have chosen to offer exclusive CERPIs for AFORE and/or SIEFORE, which allows their strategy to be differentiated. The size of assets under management and costs have also been differentiators, amongst others.

In the case of the CERPIs that were placed in 2021, the dominant sector was that of fund of funds, while in the case of the CKDs, it was the real estate sector, as can be seen in the following table.

The amounts committed might seem high in several cases since they are part of the strategy of having vehicles for the current and future resources that the AFOREs will allocate. Here one must consider that the AFOREs double their assets practically every five years.

Throughout 2021, 10 CKDs and CERPIs began their initial process of listing on the stock exchange. Their main takeaways are:

They want to issue 5 CKDs and 5 CERPIs.
7 started the procedure in BIVA and 3 in BMV
Among the 5 CERPIs, 3 are funds of funds; one in the energy sector and the other one in real estate. There is only one new manager.
Among the 5 CKDs are 3 real estate and 2 in private debt. There are 3 potential new issuers.

In the issuance of new private equity vehicles and feeders, from 2019 there are 8 issuers that started their placement process and from 2020 there are 5 that are pending. Historical experience tells us that of these 13 laggards, only some could be issued, being more difficult for those from 2019 (three years ago) than for those of 2020 and 2021 (one or two years ago).

At the beginning of the year Lock Capital Solutions (feeder) issued LOCKXPI (#21) with a first capital call of US $2.7 million and commitments up to US $840 million.

Although the trend in recent years favors the issuance of CERPIs, the issuance of CKDs continues to be selective, although not quite what was seen with the 2015-2018 boom.

Column by Arturo Hanono

Should I Stay or Should I Go?

| For IreneValiente | 0 Comentarios

music-g06c7d1989_1920 — Pixabay CC0 Public Domain. Should I Stay or Should I Go?

After three consecutive years of extraordinary equity markets returns – the last two while the economy was being savaged by the pandemic – investors, as in the famous song of The Clash, are singing to themselves: “Should I stay or should I go?”

Many see similarities between the historical period that preceded said song, and our time. When punk-rock emerged in the mid-1970s, the world economy was mired down by persistent inflation; caused in large part by growing union power coupled with misguided monetary and fiscal policies. The concern is that the comparisons do not end there, and that as happened back then we will suffer another lost decade for equity markets.

But comparative history requires us to be very careful with the context. Lessons were learned from that period, and in 1982, when the band released their most celebrated song, the economic policies that had led to high inflation were beginning to reverse in full force; ushering in the period of greatest macroeconomic stability ever experienced.

In the decades that followed the charge against inflation led by Chairman Volcker, corporate profits boomed. The liberalization of trade and finance (accelerated after the fall of communism), as well as the productivity increases brought about by the introduction of personal computers and the Internet, also contributed greatly.

We are still benefiting vastly from these events, which have not only contributed to global economic growth, but have also proven to be key to keeping inflation in check. Offshoring (or the threat of it) significantly reduced collective bargaining power in developed countries; and technology, combined with globalization, contributed to the drastic cheapening of many goods and services.

To infer that because we have had a bout of inflation we are going to go straight back to the 70s is a very naïve interpretation of economic history. The pandemic has altered the prevailing economic regime in the short term, but it hardly has the potential to fundamentally change it. It is supply-side constraints that have been responsible for the recent surge in inflation, not fiscal and monetary largesse. In fact, without the support from governments and central banks we would have experienced a deep (and deflationary), recession.

Proof that past mistakes are unlikely to be repeated is that the Fed has announced (earlier than expected) that it will begin to dial down its support. Therefore, the main risk for the economy is not falling into a 70s-style stagflation trap, but rather that the dose of stimulus has had to be so disproportionate that reducing it can easily cause “withdrawal symptoms”.

This helps explain the apparent paradox of long-term interest rates remaining stubbornly low while inflation reaches levels not seen in decades, all while the Fed is about to begin tightening. The reading is clear, the bond market is discounting that either inflation eases, or the Fed will have no choice but to cool demand to prevent a price spiral.

For investors, the key takeaway of all that has happened in 2020 is that the thesis of “lower for longer” interest rates has successfully passed an extreme stress test. If rates have barely increased, despite inflation nearing 7%, when will they?

With this in mind, investors should not be overly concerned about a valuation shock. However, they do have to worry about the sustainability of the recovery, as any sign that the economy is slowing down could cause a major correction in equity markets. With this in mind and contrary to the prevailing narrative, Growth stocks should be less vulnerable than Value and Cyclicals.

In a way, the year that begins marks the return of “business as usual” for investors; with corporate profits back to center stage. And here the risk goes both ways. On the one hand, we can see a reversal to the historical trend, given that the pandemic appears to have provided a counterintuitive boost to earnings. But on the other hand, the trend may continue as long as the corporate world continues to profit (with winners and losers) from the digitization push; something that the pandemic has accelerated even further.

This is the implicit wager of being long equities these days. The only certainty we have is that it will be next to impossible to repeat a year like 2021, in which all S&P 500 sectors had positive returns, and the index reached 70 new highs. But since bonds hardly offer an alternative, the opportunity cost of not staying invested is simply too high if a correction does not finally occur. Or giving a twist to the song, “If I stay there will be trouble (…) And if I go it will be double (…)”.