Global equities continue to face challenges despite inflation pause

Oksana Patron

29 June 2023

Although the risk of further inflation rise has abated, the global equities will still face a number of challenges which will be the result of high levels of inflation and interest rates, coupled with slowing demand, according to American Century Investments.

The manager’s senior portfolio manager, Brent Puff, believed that the pace of rate increases by the US Federal Reserve and global central banks would slow, however because aspects of inflation were proving sticky, interest rates would not fall immediately.

Puff also stressed that monetary policy was weighing heavily on the US housing market, which accounted for a large portion of US GDP, and the recent US banking crisis led to a reexamining of exposure to the financials sector amid the continuing uncertainty.

“It’s fair to say we have been stress-testing our assumptions. We’re looking at the impact lower rates and higher credit losses could have and considering various macro assumptions.

“We have adjusted our earnings expectations but we also have considered the new outlook in the context of current valuations and trimmed our exposure to US banks, in particular,” he said.

According to Trevor Gurwich, another American Century’s senior portfolio manager, there would be a greater focus on company fundamentals as opposed to macro events which was undoubtedly driving equity markets over the past year.

“Given the slowing economic growth in the US and parts of Europe, investors will need to ensure their portfolios are comprised of companies with diverse growth drivers,” he said.

“It’s also region-dependent, as Europe and the US, for example, are potentially more exposed to slowing economic growth, whereas the dynamics in Japan, both from an inflation and growth perspective, are different. We are seeing opportunities as Japan’s economy continues to benefit from re-opening.”

On top of that, diversification would be key in this market, with compelling bottom-up opportunities with diverse drivers of earnings growth such as companies that were benefiting as economies in Asia re-opened, trends towards near-shoring, and an acceleration in demand for medical procedures post-Covid.

“Small caps have lagged their large cap peers, but that may create opportunity for small cap investors. The headwinds that have weighed on small cap performance, including inflationary pressures, appear to be easing. The combination of attractive small cap valuations and a wide range of small cap companies with accelerating earnings growth bodes well for small cap returns,” he said.

Gurwich also added that he saw both risk and opportunities for companies related to artificial intelligence.

“Investors need to understand which companies may benefit from the adoption of AI, and to analyse how material the impact will be on company fundamentals,” he added.

“Potential beneficiaries include select semi-conductor and data center companies. It’s also important to consider the risk that adopting AI may present to companies, including lower-end software developers or online education companies.

“The integration of AI has the potential to improve the quality of services and, in turn, translate into commercial success. However, it is important to differentiate between hype and reality by objectively focusing on company fundamentals.”