Identifying Global Equity Opportunities as Some Headwinds Abate

Macroeconomic Headwinds Dominated in 2022

The rapid rise in interest rates and the subsequent increase in the cost of capital contributed to a broad slide in the price of most risk assets in 2022. The repercussions of Russia’s invasion of Ukraine and the lingering impact of COVID also pressured capital markets.

Only a handful of stock market sectors and industries delivered positive returns in this environment. Value-oriented sectors, including energy, utilities and consumer staples, outperformed traditional growth sectors, such as technology, consumer discretionary and communications services. Value beat growth by a wide margin.

We get another view of the market’s behavior in Figure 1, which shows the correlation of the price momentum factor with the value, dividend yield and growth factors. Both value and dividend yield correlated positively with positive price momentum over the second half of 2022.

The relative strength in these factors hasn’t been this extreme in more than 20 years. At the same time, momentum in the growth factor has turned negative, reaching a level that we haven’t seen since the dot-com bubble burst in 2001.

Investors Seek Earnings Certainty

With recession worries rising, many high-growth stocks with little to no current earnings have experienced significant drawdowns. This trend has been especially acute in the health care sector. Last year’s strongest health care performers were defensive and didn’t present the greatest opportunity for future profitable growth. Put simply, investors paid for safety at the expense of growth.

This phenomenon hindered performance among companies that we believe are well-positioned to benefit from long-lasting secular opportunities. Examples include outsourced manufacturing and clinical trials and research. While many of these companies face near-term risks due to the slowing macroeconomic environment, we believe their long-term growth outlook remains attractive. We expect demographic trends to help health care R&D spending outpace GDP growth for many years.

We also saw similar examples in information technology and consumer staples. More defensively positioned companies outperformed, so avoiding or underweighting such firms proved costly.

Our Global Growth Equity Outlook for 2023

Tight monetary policy remains a challenge, but we expect the pace of interest rate hikes to slow as central bankers assess the impact of their policies. In the U.S., many aspects of the economy are starting to show the desired effect of slowing demand. For example, the housing market has softened considerably due to mortgage rates climbing from about 2% to a recent high of 7%. This is significant because housing accounts for up to 20% of U.S. GDP growth.

In addition, earnings announced late last year revealed that retailers are struggling with unsold inventories, indicating that demand for consumer goods has started to slow. While the U.S. consumer is still spending, any excess savings built up during the pandemic have largely been spent.

Still, the Federal Reserve’s job isn’t done. The labor market remains relatively healthy, though we see signs that the U.S. labor market is softening. The ratio of jobs to job seekers is starting to improve. Many large corporations — especially in technology and finance — have announced hiring freezes and layoffs.

With recession risk rising, we think it’s important to balance potential growth opportunities with earnings sustainability and valuation. We continue to see opportunities in companies with earnings resilience, strong balance sheets, manageable leverage and company-specific strengths. We believe those that don’t depend on the economic cycle to grow and deliver profits will likely be rewarded as growth become increasingly scarce.