Persistently high inflation is forcing central banks to respond at the most aggressive pace since before the Global Financial Crisis. The breadth of global central bank tightening is reaching its highest in 15 years.
The reason is clear – if inflation pressure were to continue, then there would almost certainly be further pressure on risk assets – in particular those which have the highest valuations.
The number of companies still trading at lofty valuations remains at historical highs. The chart below shows the percentage of US companies selling at more than 10x sales. During the Tech bubble, this figure peaked at 14.3% before falling back to its pre-bubble peak. Even after the recent market decline the current percentage remains above the peak percentage of the dotcom era. With easy monetary policy coming to an end, we suspect this figure will reset.
Source: Strategas Research Partners
Other areas of the markets are also highlighting the potential cracks in risk assets. The chart below, which shows the performance of Consumer Discretionary versus Consumer Staples is one example of this.
Source: Strategas Research Partners
As inflationary pressures have intensified, the Consumer Discretionary sector has experienced a magnitude of underperformance that has historically occurred only immediately prior to and during recessions (shaded red areas).
Given the increased uncertain investment backdrop, the obvious question remains: where are the best areas for equity investors to hide until more clarity returns. The chart below shows the relative performance of four of the most important factors driving equity performance – Value, Growth, Dividends and Size (market cap). As market volatility has increased the relative performance of cheaply valued and high dividend paying stocks has increased at the expense of those stocks whose high valuations are dependent on meeting high growth expectations that will prove unrealistic in the majority of cases.
Similar to the situation after the dotcom bubble we expect our exposure to value stocks will provide not only continued outperformance, but also the highest chance of positive absolute returns (as was the case in the 2000 – 2003 period). As we have said before, the value cycle is only just beginning, and will likely have many years to go.
Source: Strategas Research Partners
ABOUT THE AUTHOR
David Williams (1970) is responsible for the investment policy of Mpartners. After a brief career in diplomacy with the Ministry of Foreign affairs in Barbados, David joined Insinger de Beaufort asset management in 1997 and became a director in 2002. He was responsible for the investment team and the investment funds (long-only and hedged). His specialism is European equities. David holds a B.A. (Hons) from the University of Kent, an M.Sc. from the London School of Economics and an M.B.A. from Nijenrode university.
