Although the environment for investment cannot be considered easy by any means, there are, for the first time in a long time, positive nominal interest rates on holding cash, says Johanna Kyrklund, Schroders’ chief investment officer.

“This changes the investment dynamic considerably compared [with] a couple of years ago, when we were forced to buy ever-more expensive assets in a world of endless liquidity to generate return,” she says.

In recent months, the mindsets of investors have moved from denial to acceptance in terms of their expectations of central bank hikes. Market expectations are now reasonable. This is a big change compared with last summer.

Diverging central bank policies, driven by differing levels of inflation, exposure to the energy crisis and the pandemic, also create opportunities within asset classes. 

Kyrklund says that although the world will most likely still have to work through a recession in 2023, the 2001 recession showed that economies recover at different speeds.

“This makes it interesting from an investment perspective and I certainly think this will be a great opportunity over the next couple of years,” she says.

Kyrklund points out that emerging markets, for example, were far quicker to deal with inflation last year, so they’re getting very near to the end of their tightening cycle. “They’ve already taken a great deal of pain by preemptively raising rates, and we now see some value in emerging market assets.”

Kyrklund cautions that inflation is the key to market performance in 2023: “Provided inflation does come down, we could start to see a more benign environment for markets. But if inflation persists, then we’ve got a problem on our hands. Rates might then have to go even higher, and markets would have to reassess valuations once again.

“However, compared to the volatility of 2022, we expect interest rates, and therefore fixed income, to be more stable in 2023, allowing investors to take advantage of the yields on offer. Indeed, the appeal of bonds has changed from their diversification benefits to their yields,” she says.

When it comes to equities, Kyrklund thinks valuations are less attractive than bonds and she anticipates that earnings expectations are likely to drop further on the back of recessionary risks.

On the flip side, there is potentially more opportunity within equities.

“After years of unrelenting outperformance by the US, driven by the strength of the technology sector, markets outside the US now look very cheap. But investors will need to be more discerning and selective, both on countries and companies, in this new environment. There will be an increased divergence between the winners and losers in both fixed-income and equity markets. 

“We should also remember that historically some of the best opportunities for equities occur during recessions. Markets always move ahead of economic news. So, in 2023, investors need to focus on valuations, not on the newspaper headlines,” Kyrklund advises.

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Faith in growth stocks

Michele Santangelo, portfolio manager at Independent Securities, agrees — although he has more faith in growth stocks, noting that these stocks in particular, have been pushed to stratospheric levels only to halve and halve again.

“Inflation has spiked to levels last seen 40 years ago, forcing central banks around the world to aggressively raise interest rates to contain inflationary pressures. As interest rates and bond yields have risen investors’ opportunity set for earning a reasonable yield has grown,” he says.  

Slowing economic growth and recession fears have also dampened the general growth outlook, leading to depressed valuations, particularly for high-growth shares whose valuations are tied to their ability to grow top-line revenue into the future.

“The headwinds impacting stock markets have meant the Nasdaq Index, which is typically representative of high-growth tech companies, has fallen by 35%. The Nasdaq Index is in deep bear market territory, but the mega-cap technology stocks have masked the true carnage that has occurred for smaller and mid-sized companies,” says Santangelo.

“Bear markets are painful, but fortunes are made in bear markets and not bull markets.  This is because assets can be purchased at highly depressed valuations relative to their potential.”

Santangelo notes that current negativity towards growth shares is typical of the short-termism that dominates financial markets and provides an opportunity for investors with a longer-term perspective.

“At this point, investors need to determine which companies have sustainable business models that are growing despite the macroeconomic headwinds and that can be purchased at valuations closer to the lower end of their historical range,” he says.

He cautions that the distinction between structural growth companies and momentum growth companies is also important as momentum growth typically ends abruptly.

“A great example of a momentum growth company is Zoom, the video meeting software that became commonly used during the pandemic. Zoom is a good company and received a big boost. However, it does not have a real competitive advantage, nor any type of moat, and its growth momentum is unlikely to be sustainable,” notes Santangelo.

On the other hand, sectors that do benefit from structural growth tailwinds include software, fintech, blockchain, wellness, clean energy, electric vehicles, agritech, biotech, luxury goods, medical devices and semiconductors. 

Santangelo says the key in these sectors is to determine which companies are best placed to benefit from these trends and whether they can be bought at reasonable prices that justify their future prospects with a reasonable level of confidence.

Growth companies

The growth companies Santangelo sees potential in, as well as his reasoning for optimism, include:

• Adobe stands out as a high-quality growth company trading at an attractive valuation when compared with its history. Adobe is the quintessential software as a service (SaaS) company, with products that are critical to the digital age.
• Booking.com is also trading at a reasonable valuation and stands to benefit from the travel spending boom that has emerged post-Covid.
• In the luxury goods sector, Canada Goose offers a good combination of value, quality and growth. Demand is resilient for luxury goods and Canada Goose’s famous parka jackets remain in high demand across existing and new growing markets. The renowned quality of their products, coupled with the launch of new categories such as shoes and accessories provide a strong growth underpin.
• Crowdstrike is a great example of a high-growth company. As the sophistication and frequency of cybercrime continues to grow, the cybersecurity sector remains recession-proof. The companies that operate in this sector need to have cybersecurity technology solutions that are ahead of their peers. Those that are technologically superior will continue to grow at an attractive pace as customers continue to deploy capital to keep their businesses and their customers protected.
• Illumina has great potential in the biotech sector. This sector is trading close to its cash levels, meaning investors can buy these companies at the same value as their cash holdings and essentially own their intellectual property for free. Illumina provides the tools required for genomic testing while controlling more than 80% of a growing market. BM/DM