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‘Rampant speculative activity’ coming to an end – Bell AM

Equities

Inflation and rate rises are back on the table it seems, after this week’s US Federal Reserve Board meeting, Chairman Jerome Powell indicated that rate hikes could come in 2023, but no mention of when scaling back of bond buying would begin. His comments took markets by surprise signalling a change in policy sooner than expected.

The first-rate rise was largely expected to occur in 2024 followed by a ‘lift-off’ in rates throughout the year. Some analysts even see rates moving higher next year. Projections have its preferred measure of inflation rising to 3.4 percent this year, a full percentage point higher than its March forecast. Looking past inflation and interest rates, the statement is a strong vote of confidence that the US recovery is on track.


With inflation and interest rates now likely to rise sooner than expected, Bell Asset Management’s Senior Global Equities Analyst, Joel Connell, explains the drive back to company fundamentals from growth. Connell says “Typically, in the early stages of a cyclical recovery when inflation expectations start to rise, we see the market gravitate towards the perceived beneficiaries including commodity producers, banks and many cyclical industrials. It has been no different this time around, with strong outperformance of many of the cyclical and rate sensitive parts of the market since the positive vaccine data started to emerge in early November 2020.”

  • To add to it, the pandemic saw a bout of “rampant speculative activity” drive share prices of unprofitable companies to unfathomable highs. The real concern here is that “as concerns over rising inflation and higher interest rates continue to build, we feel this could be a catalyst for market participants to return their focus to some of the key fundamentals which have arguably been ignored during the early stages of the cyclical recovery,” says Connell.

    The philosophy at Bell Asset Management is to invest in only quality at a reasonable price. That means, the team only invest in only high-quality companies but don’t overpay for them. For example, the investible universe for the global small-mid cap strategy is small mid cap stocks in developed markets and there’s effective 150 names the team focus on.

    Looking forward, Connell believes their “quality at a reasonable price’ investment strategy is positioned well to outperform in an inflationary and rising rate environment due to exposure to companies with good pricing power, strong balance sheets and highly visible cash flows, and less exposure to companies with high valuation risk. We also believe maintaining a portfolio with these key attributes has been a key reason why we have been able to outperform during historical periods of rising inflation and interest rates.”

    In the short term, Connell says returns will be cyclical and rate sensitive in nature driven by a valuation re-rating. “Once this re-rating occurs, we believe the focus will inevitably start shifting back to more fundamental factors such as long-term earnings growth, balance sheets and cash flows.” At the early stages of a cyclical recovery, share prices of poor-quality companies tend to rise to unsustainable levels.  

    Connell concludes by saying, “If fears over rising inflation and higher interest rates continue to grow, we believe this could be a catalyst for market participants to return their focus to some of the key fundamentals which have arguably been ignored during the early stages of the cyclical recovery. In our view, some of the most important company attributes for investors to consider during periods of rising inflation and higher interest rates” are “companies with good pricing power, strong balance sheets and highly visible cash flows, and less exposure to companies with high valuation risk.”




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