Stock pickers at the end of the free money era
Portfolio Manager Luke Newman explores what a change in market dynamics means for long/short investors.
3 minute watch
- Recessionary pressures and the risk of a higher default cycle have led to a change in investor appetite and an end to the speculative excesses we have seen over the past few years.
- A return to higher dispersion levels between the pricing for individual securities presents an opportunity for stock pickers to re-introduce valuation techniques that have been sidelined over much of the past decade.
- Higher dispersion levels represent a particularly attractive environment for long/short investors able to distinguish between those businesses thriving, and those that are struggling.
Changes in investment paradigm and new regimes for market structure are not common events, but it has become clear over the last six or seven months that we have seen a new period for markets and for economies. The dormant levels of inflation of the last decade seem to be behind us, and we have entered a new period that comes with lots of consequences for economies as well as investing.
The chances of a default cycle, recessionary pressures are now very real. We’ve seen investor appetite change and the speculative excesses of the last few years, again feel behind us. Financing rates are now higher, but the strong sense we have and when we look back to earlier points in our investment careers is that this is a much more normal environment to be investing within.
Within equity markets, what we have seen is a return to higher dispersion levels between individual securities and with it the opportunity for stock pickers to be able to employ valuation techniques and approaches that over much of the last decade have been relegated and replaced really with a single objective of managing to a single factor – that dominant growth style factor which has dominated markets for so long.
The question now turns to the persistency of this new regime. How long will these new dynamics last within equity and fixed income markets?
Our strong sense is that all policy makers in the western world, in particular central banks and governments, are keen to move away permanently from this era of free money and zero interest rates. And there is a determination, even if we do see pressure on gross domestic product (GDP) and recessionary forces to not return to a period of negative or zero interest rates going forward.
It is clear, I think, to all of us now that there have been unintended consequences, both economic and social, in terms of inequality trends that have been caused by these policies, and a return, again to a more normal form of investment allocation of resources, would seem to be preferable. If we are right in terms of that assertion, this improvement in opportunity set we have seen for stock pickers, particularly for long/short investors who can benefit from deteriorating conditions as much as those businesses and companies thriving in this environment should continue to be very strong indeed, and importantly, much improved on what we have seen for much of the last decade.
Inflation: The rate at which the prices of goods and services are rising in an economy. The CPI (consumer price index) and RPI (retail price index) are two common measures.
Recession: A significant and prolonged downturn in economic activity, commonly considered to be at least two consecutive quarters of falling GDP (gross domestic product).
Default/default cycle: The failure of a debtor (such as a bond issuer) to pay interest or to return an original amount loaned when due. A period in the market cycle when default levels are increasing in response to more difficult economic conditions.