Turbulent times ahead

2022 currently feels like a perfect storm: lingering COVID, war in Ukraine, the return of inflation, recession. There have been very little places to hide as markets are absorbing the daily grind of bad news.

Investors are torn between several negative narratives and there is very little visibility between the proponents of a durable return of inflation, a deep recession or durable slowdown of economic activity or the ones who forecast a period of destructive stagflation (a phenomenon rarely observed). Most importantly, the dramatic aggression of Ukraine by its neighbour and the catastrophic geopolitical background makes reading the tea leaves almost impossible. With this level of extreme uncertainty, most investors are now keeping their powder dry and waiting for more clarity to come both with regards to the conflict and the direction of the economy.

Focus on company quality rather than on aggressive bets

As we have repeatedly stressed, very few market participants have been able to successfully time markets and we would be at a loss to make a powerful call in any direction. Experience tells us nonetheless that luck favours long term investors and that the people who are prepared to hold on to high quality companies at the right price end up benefitting much more than the ones that are waging everything on one scenario over another, especially in such a high level of uncertainty. For a very long time, we have been advocating taking the long-term view and investing in quality companies that will weather the storms.

A few themes remain promising

Additionally, despite the extremely unstable background, a few themes are emerging for the future, such as the acceleration of the energy transition and the massive investment still needed in our infrastructures worldwide. These are structural trends that will reverberate in the economy for many years to come and we see no abating in the massive investment flows in these sectors. If anything, Europe’s dependence on Russian oil and gas is likely to accelerate the transition to a greener world.

The same countercyclical story is true for some Far Easter economies. For example, the Japanese corporate world continues its transformation towards more shareholders value and the likely outcome will be more stable returns for equity investors in that country. This will not be influenced by the debate of inflation vs recession. A similar case can be made for China and other Asian economies which are not at the same stage of the economic cycle. As they are trying to restart activity on the back of very stringent COVID policies, several countries are likely to increase support massively for economic activity. This will lead to greater earning growth and as valuations stand at a discount today to Wester markets, it does provide a strong opportunity for the discerning investors.

Most certainly, diversification away from the winners of the past will be a very profitable exercise as the winners of the past 10 years are unlikely to produce similar returns in the future, both at the stock level, but also at the sector level and geographically.

The foretold return of active management

This is probably one of the most important stories in financial markets for the coming decade: as interest rates were kept artificially low for more than 10 years, a few growth stories did emerge as the darling of the investment community. The meteoric rise of stocks such as Apple, Tesla or Amazon allowed for easy picking in the markets. As these large growth stories became an ever-larger part of the indices, passive investment was the rage. Buying an index and replicating the market where the ever-larger FAANGS (feel free to add a few letters to accommodate another 10 stocks) was the easiest route to financial success. With such a simple investment mantra, many were calling for the end of active management. Larger passive asset management groups concentrated the majority if not the totality of inflows and commentators were calling the end of the investment boutiques. Alas, trees to not grow to the sky! With a more uncertain world and such an increase in volatility, indiscriminate investment strategies are likely to be challenged and we anticipate a strong recovery of the active asset management sector. The ability to successfully pick stocks, as opposed to buying momentum indiscriminately will be the key factor of success in the coming decade. It should restore some balance in the financial markets and makes a strong case for manager diversification and the return of investment boutiques.

At Quaero Capital, we continue to believe in managing concentrated and active portfolios. As we enter a more complicated world and an investment environment fraught with uncertainty, focusing on a small number of concentrated investments should provide a better outcome than following the crowd passively.