Bruce Stout, manager of Murray International Trust, sees shifting priorities from investors: “In the past few years, financial markets have been obsessed with everything ‘e’ – e-banking, e-learning, e-commerce. When we look forward, this could be the year of the ‘i’ – infection, interest rates and inflation. With infection, it’s hard to forecast and we’re just hoping for no new variants, but in terms of interest rates and inflation, these two factors are likely to dominate.”
Bruce is clear that high inflation is more than simply a response to supply chain issues, it is also demand-led: “The longer inflation indices linger at 5-7%, the more that will feed into wages. That will have an implication for businesses that are labour intensive. When inflation goes into wages, it’s very sticky. That shapes the businesses we’re looking for.”
This has already started to be reflected in markets since the start of 2022, with a sell-off for high growth technology companies and rotation into more unloved areas. Thomas Moore, manager of Aberdeen Standard Equity Income Trust, says: “In recent years, people have assumed that a narrow range of concept stocks will keep going up forever, but there are now strong drivers for a rotation. The market environment has changed and the first few weeks of January were characterised by a violent rotation out of new economy sectors.”
There is also an increasing gap between the fortunes of different countries. Different approaches to Covid and vaccine progress have created a range of economic outcomes. Equally, not all countries are feeling inflation in the same way. China, for example, has more flexibility to loosen monetary policy, while at the other extreme Brazil has been forced to tighten its policy in response to double-digit inflation.
Hugh Young, manager of Aberdeen Standard Asia Focus, says: “Asia is slightly more in charge of its own destiny, certainly on the monetary policy front. Across the region, we are seeing a very strong pick up in earnings, a combination of both recovery and real underlying growth. One of the big issues that we can never predict is politics. There, things could wobble.”
Equity versus bondsAgainst this new backdrop, equities appear to offer greater protection against inflation than bond markets. Bruce says: “It is difficult to make an argument for bonds when inflation is at 7%. We see the highest negative real bond yields that we’ve ever seen in the US. There is huge scope for bond yields to rise unless central banks can continue this financial repression. For us, it suggests the outlook for equities is a lot better than the outlook for bonds.”
That said, there remains a danger that equities could get caught up in rising bond yields. Thomas says: “Once the artificial support for bonds is removed, yields do not make sense. That could have an important impact on different sector performance this year. We’re building that consideration into our portfolios.”
Leaders and laggardsThis changing landscape is reflected across the abrdn investment trust portfolios. For example, Murray International is increasingly invested in companies with real assets – pipelines or digital networks, for example – which should be able to push through inflationary pricing. Bruce is also looking at companies with operational leverage, particularly in Asia. Thomas says the Aberdeen Standard Equity Income Trust is “ready for the rotation”, with selective investments in commodities and financials (which should benefit from rates rising).
Hugh is still investing in many of the themes that have characterised the portfolio since inception - from growing wealth, to changing consumer habits, to the adoption of new ideas. He says: “The out and out winners have been e-commerce type companies. At the margin, we’ve been shifting away from those. As always with this type of company, investors need to be sensible and not over-pay.” He is also being careful to avoid labour-intensive businesses, which are likely to struggle at a time of labour shortages and wage inflation.
Revival of income?Income strategies have lagged other investment approaches in recent years, in spite of a strong revival in dividends in 2021. Bruce says this may change in the year ahead: “Income never really goes out of favour because people need it, particularly retired people. People tend to focus on income when inflation comes back.” Bruce adds: “We expect significant improvement in already good dividends in Asia this year. A lot of the regulations that were put on the banking sector after Covid have been eased now. In the banking sector, banks are paying nothing for deposits, but can charge more for loans. That flows to the bottom line. Telecoms companies are emerging from considerable capital investment. That capex can now ease and cash flows are picking up. The outlook for dividends for the type of businesses we own looks encouraging over the next couple of years.”
Optimism vs pessimismNo-one is predicting an easy year in 2022. Rising interest rates and inflation create a difficult backdrop for the stock market to make headway. However, there is an opportunity in the market turning away from technology companies to other areas, which may benefit from both rising earnings growth and expansion in their valuations as investors reappraise their prospects.
Hugh concludes: “Our businesses are market leaders in strong market positions with great balance sheets. Earnings will rise, valuations are reasonable. It is always difficult to predict how markets will value them, but I’m optimistic about the underlying businesses for the year ahead.”
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
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