Global Factor Views: Positive on ‘Quality’ equities
- Global growth continues to feel the pressure in the current macroeconomic environment
- The central bank tightening cycle is mostly priced in, limiting further bond yield upside
- Equities are looking cheaper in relative terms, and we presently favour 'Quality' stocks
The Ukraine war continues to pose a material supply-side shock, driving inflation higher and slowing post-pandemic growth. Given the present backdrop, we forecast global growth to rise by 3.1% this year and 2.8% in 2023.
Inflation has not yet peaked, and most central banks will continue to raise interest rates and tighten policy, although much of the anticipated tightening is now priced in, limiting further bond yield upside. In our view equity valuations now look reasonable but not cheap.1
However, given where we are now - elevated inflation and risks to growth - we anticipate that corporate earnings will come under pressure in the coming months and as such we advocate caution for the rest of 2022.
Given the present environment, we outline our outlook for equity market factors below:
Quality - i.e. companies with more consistent earnings and typically less share price volatility - did not deliver its normal level of defensiveness during the market correction during the first half of 2022.
This is chiefly because of its lack of oil exposure and because ‘quality growth’ de-rated, as real interest rates (taking inflation into account) rose.
However, we remain positive on Quality stocks because we do not expect significant further increases in real yields - bond interest payments after accounting for inflation - meaning the de-rating headwinds experienced by ‘quality growth’ is likely to be behind us.
Furthermore, corporates face a slow growth or even recessionary macroeconomic outlook, and earnings growth is likely to slow. As such, we believe investors will favour - and may even pay a premium for - companies with a proven track record of earnings growth or which are beneficiaries of secular growth trends, such as the transition to a clean economy.
Low volatility: Neutral
The Ukraine crisis has added to inflationary pressures but damaged global growth expectations and investor risk appetite, leading to a sharp equity market correction.
Against this backdrop, it should come as no surprise that lower volatility stocks - those which in relative terms generally experience lower levels of volatility - outperformed the market in the first half of the year.
A slow growth or even recessionary macroeconomic outlook continues to argue in favour of the defensive attributes of the style. However, we remain neutral because Low volatility price-to-earnings (P/E) multiples are relatively elevated, and the style would likely underperform sharply in a scenario where macro conditions surprise on the upside.
We moved overweight Value in January (maintaining that position despite the outbreak of the Russia-Ukraine war) because rising real rate expectations favoured short duration stocks and Value – stocks which appear to be trading for less than their underlying value - was cheap.
But we have downgraded our outlook for Value to neutral because we do not expect further significant increases in real yields and the outperformance of Value this year means that the valuation gap between Value and Growth has normalised.
We remain neutral as the current uncertain macro and geopolitical outlook still argues in favour some ‘defensive value’ sectors and, while Value is no longer relatively cheap, neither is it relatively expensive.
Price momentum as a factor captures stocks that have a positive price change, relative to the market, over the last 12 months.
Currently price momentum is correlated with low volatility and defensive areas of the market. We would prefer to obtain defensive exposure directly and as such recommend an underweight position in price momentum to avoid over-exposure to a scenario where macro conditions surprise on the upside and markets sharply reverse.
With a more demanding outlook for corporate earnings, our preferred measure of investor sentiment continues to be the momentum of near-term earnings revisions.