Theoret says he expects the present high level of inflation to dissipate later this year, and presents a dilemma for clients.
If the level of inflation begins to fall just as higher rates are being deployed, that would typically be assumed to lead to GDP growth declining, and a sign that an economy may be exiting the expansion stage, and approaching the downturn.
Theoret says: “When you look at the equities that have performed well, it is not the most cyclical equities. In fact many areas such as telecoms and utilities have done well. Those tend to offer inflation protection, but also are quite defensive in nature. So although we are early in the cycle, the equity market is already behaving as though we are late in the cycle.”
He says that, rather than the next phase being a recession, it could be that growth decelerates, and we revert back to the recovery stage.
Kevin Thozet, investment committee member at Carmignac, says that rather than macroeconomic events, company earnings should be the main determinant of whether the time is right to own value shares.
He says that companies revising upwards their forecasts is a sign of the expansion phase beginning, “but it now looks as though we are past the peak of that. Growth is decelerating, inflation is decelerating.”
Andrzej Pioch, multi-asset investor at LGIM, notes that even if economies are in the late cycle phase, it can still be positive for equities.
He says: “The risk in this sort of economic climate is that interest rates get hiked too quickly, more quickly than the market expects, and that leads to equities doing badly late in the cycle. But this time, the market’s expectation around interest rate rises has been revised sharply, it would take quite a lot for rates to rise faster than the market now expects, and so the outlook for equities is a bit clearer.”
Stephanie Butcher, chief investment officer at Invesco, says: “We are moving away from what had been the dominant view, which is that we were set for a long period of low growth and low inflation. What is happening now is some element of normalisation, with evidence of pricing power coming into the economy. This means that, as interest rates rise, so does the risk-free rate.
"When the risk-free rate was zero, investors were happy to apply an almost infinite valuation multiple to early stage companies, but as the risk-free rate rises along with interest rates, valuation matters again, and that is why we have seen some of the growth type equities sell-off.”
In terms of what may come next, Butcher says: “It depends where we are in the cycle, but while it has been very binary as value versus growth for a while, now we are in a situation where individual stock picking, and individual company results, will matter. Some tech stocks will do well, and so will some more cyclical assets.”
