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2023 had a knack of keeping investors on their toes. On a macroeconomic level, uncertainty around the direction of interest rates and inflation made it difficult for investors to understand how best to position portfolios amid recession concerns. The markets contributed their own challenges, with equity market concentration further intensified by speculation over which megacaps might be best placed to benefit from AI. It’s no surprise that cash has been a safe haven for investors recently, especially given the attractive levels of income on offer.
When the road ahead is unclear, playing it safe can be a logical approach. However, I think there are ways to extract clarity from a seemingly incoherent investment landscape. One way of thinking about this year is as a bridge between two different investment environments — the old and the new. I see this transitional period as having characteristics of both regimes.
The old environment was characterised by low and stable inflation, near-zero interest rates and moderate economic growth, supported by a policymaker focus on economic efficiency. Globalisation gave rise to increasingly free movement of goods, services and people.
By contrast, the new environment is likely to look quite different. Investors can expect higher and more variable inflation, higher interest rates and fluctuating economic growth. With policymakers likely needing to focus their attention on a new set of priorities, such as inequality and strategic autonomy, economic efficiency may fall by the wayside. Globalisation is beginning to unwind, creating barriers for cross-border flows and fracturing supply chains.
This journey between these two regimes is further complicated by its backdrop: concentrated equity markets, a complex and rapidly evolving geopolitical landscape, divergent policy cycles and accelerating structural change within AI, health care and other important themes.
The transition from the old investment era to the new one is likely to be somewhat messy. The path ahead won’t be straightforward, so investors waiting for a clear trajectory forward might find themselves stuck on the sidelines. However, a number of opportunities are beginning to crystallise. The start of the year provides a good prompt for investors to review portfolios to see if they are positioned for the future, rather than the past.
We see three key areas of focus for investors.
Higher inflation and rising interest rates have been painful for investors, but there is an important flipside in the shape of yields that are now higher than they have been for a very long time. This is making fixed income a much more attractive asset class, especially now that inflation is beginning to fall and central banks appear to have stopped hiking rates.
This presents opportunities for investors looking for income in their portfolios but is also beneficial for investors seeking to grow their wealth, given the power of income to accumulate steadily over time. Consistent streams of income can also help smooth the path of returns in portfolios. Attractive investment opportunities exist across the full spectrum of fixed income as well as other income-generating assets, such as dividend-paying equities.
The old environment was generally supportive for companies, bestowing them with low funding costs along with a broadly stable macroeconomic backdrop. As capital becomes more expensive and volatility becomes the new normal, there is likely to be greater divergence between winners and losers, creating more opportunities for skilled active managers to add value.
A tougher corporate environment should also make it easier to distinguish good management teams from poor management teams, especially as many of these teams will not have been tested by similarly challenging circumstances. Companies that differentiate themselves through, for example, strengthening their supply chains or adapting and responding to labour challenges may be better placed to prosper in the coming months and years. Being able to identify well-run companies could become a powerful advantage in an increasingly competitive landscape.
Recent technological breakthroughs, especially around AI, have led to huge interest and large market rallies in specific companies. However, the best way to think about AI is not as a tactical trade but as something that fundamentally changes the future for many sectors and industries. AI is likely a multi-decade step-change — a significant turning point that will generate ongoing opportunities for investors for many years to come. However, understanding which companies are likely to benefit and which companies are likely to be left behind is a complex task, requiring a deep understanding of changes within technology, business models and society.
Investors seeking to benefit from innovation within sectors such as technology, health care or finance should, in my view, take a holistic perspective, seeking to understand structural growth trends to capitalise on the drivers and beneficiaries of innovation.
Above all, expect a new normal. While the transition to a new investment era may continue to challenge investors, opportunities can be found, provided that portfolios are looking forwards, rather than backwards.
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