What were the major recent events and what were the impacts on your asset class?
So the quarter was pretty good in terms of earnings results as we cycled through the first half of the year into Q2. We generally had some pretty decent earnings numbers from our companies. The ones that we were particularly exposed to were the banks, which are benefiting now from rising interest rates really coming in to net interest income and therefore into earnings.
Towards the end of the quarter, we saw a big rise in the oil and gas price, which we had expected, and that led to a big outperformance by the energy stocks. So banks and energy were the two areas of the market that were the best for us in the quarter, and I think the most noticeable. We also saw some pretty good results from some of our construction- exposed companies like Kingspan and Saint-Gobain, which are particularly exposed to the energy transition to net zero, but also to some of the big spending areas and things like semiconductor fabrications and also automotive car plants, particularly for electric vehicles. Elsewhere, I think the really big event has been the rise in bond yields, particularly real bond yields. So if we look at 10-Year US TIPS they've now gone above 2.3%. And we think that the rise in real bond yields over the last two to three years has been really quite something and is highly significant. I think what is happening is markets are beginning to absorb the fact that the balance of inflationary and deflationary forces has firmly gone over to inflationary forces, which means that central banks will have to keep on bearing down on inflation through higher rates, and higher rates for longer.
On top of that, the energy transition, the transition to net zero, is going to require so much capital at a global level and for so long that we think it might tip the balance between savings and investments globally and therefore push upwards on interest rates. So these are kind of the key macro variables in terms of what it means for equities. We think in Europe in particular, it means we've got to remain focused on banks and energy as the areas that will benefit from those companies that are exposed to the energy transition to net zero, that will benefit and be very wary of many of the quality stocks that remain very expensive versus history.
So there are businesses we like that we think are good prospects, but they're just simply too expensive. And where these companies disappoint, like companies like Adyen or Lonza, they tend to get hit very hard. So we think we have to really focus on valuation and those areas of the market that have the best operating trends, which for us is banks and energy.
What can your asset class offer in the current environment?
We think the free cash flow yields and the dividend yields and the earnings growth is still positive in the areas that we are exposed to, principally banks and energy. We think there is some very good long-term structural growth trends in areas related to the energy transition. So companies like Kingspan, Saint-Gobain, Prysmian, Schneider, Atlas Copco – a bit more pricey, but a very high-quality company with pretty decent growth. So those areas will all do well.
We think some of the other areas that we have liked and still like for the very long term, like luxury or semiconductor capex, might take a step back in the short to medium term, but they're well positioned for the long term too.
What’s your outlook in the near and medium term?
So I think as regards interest rates, we're probably close to a peak. But I think it'll be a long time before rates come down and central banks will continue to have to fight inflation rather than deflation. So that's a very important shift. That means that I think for banks we'll continue to see the earnings get upgraded, not because I expect the interest rates going up further, but more because the market's pricing interest rates falling. And I think that's less likely to happen. So I think banks remain in earnings upgrade mode. And I think the cash flow coming from banks is going to be huge. So that remains an area that we think is key, as does energy. And I think other than that the trends remain in place.
We don't like to talk about growth versus value. We think it really misunderstands the investment paradigm. But if you force me into the growth versus value paradigm, I would say that value will continue to outperform growth and that we'll continue to see a de-rating of many of the stocks that have been de-rating slowly over the last two and a half years.
Is there one chart you’re currently monitoring closely?
The one that I think has moved most aggressively is real interest rates. So US-10 Year TIPS or something like that. Our hypothesis has been for a while that real interest rates would rise, but they're moving quite quickly. And I think that will upset the investment paradigm for many people who haven't really thought through the implications of all of this for different asset classes, but also within equities, the different sectors that may not do so well in an era of higher real interest rates.
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Christian Munafo of Liberty Street Advisors notes an improvement in market conditions for investors in late-stage private companies; many of these companies are similar to what public market investors used to seek in small to mid-cap growth stocks. He also stresses that many of them are not just high growth, they are also at or approaching profitability.
Goro Takahashi describes the key factors that influenced the Japanese market over the third quarter, particularly the main stock exchange’s ongoing initiative to improve listed companies’ financial indicators, and the areas he thinks investors should focus on into the turn of the year.
Julian Howard reflects on the combination of stretched valuation and a tight equity risk premium that has made equities less attractive in the short term. However, it does not undermine the very long-term case for equities, in his view. He also notes the long-term structural case for China.
GAM Systematic’s Dr Chris Longworth and Guglielmo Mazzola highlight bond sell offs and a commodities rally as significant market events, and note that systematic investment approaches can help provide investors with much-needed diversification for their portfolios.
Atlanti’s Gregoire Mivelaz highlights the three major events of Q3 that impacted his investment universe: earnings, bond call dates and the reopening of primary markets. He believes given we are now in a late credit cycle, credit quality matters for investors. And he notes that market mispricing is continuing to lead to opportunities.
Jian Shi Cortesi notes that weak sentiment in China is keeping Chinese equities at very low valuations, due to the soft economic growth, real estate drag and the ongoing China-US rivalry. However, she is optimistic about long-term prospects, with the conviction that in the long term earnings growth will drive stock prices.
Niall Gallagher shares his views on the implications of rising real bond yields and why he thinks central banks will continue to have to fight inflation rather than deflation. Niall also discusses the sheer scale of capital required to enable the energy transition, and some of the companies he believes stand to capitalise.
European Equities – We remain positive on the prospects for the European banking sector; market pricing of the stocks has failed to appreciate the sustainable nature of the increase in earnings and return on equity from a return to positive interest rates
GAM Investments’ Niall Gallagher explains why he believes investors must adapt to a new global post-deflation environment, highlights how he aims to capitalise on opportunities in the new era of higher inflation and the challenging energy transition, and states his long-term positive view on the luxury sector.
At GAM Investments’ latest Active Thinking forum, David Dowsett highlights the four key issues he will be watching going into the second half of the year. Niall Gallagher discusses a strong earnings season for European equities and shares his thoughts on the European banking sector.
Niall Gallagher, Investment Director, Europe Equities, argues that the US Inflation Reduction Act is hugely important in the context of the drive towards decarbonisation, as well as the scope for significant investment in more resilient supply chains and a move towards a more regional, less global approach.