How have the higher cost of capital and tighter credit conditions influenced your investment approach?

While the Federal Reserve (Fed) appears to be near the end of its tightening cycle, we are mindful that the effects of rate increases have yet to be fully felt in the broader economy. With slower real growth likely, we are focused on higher quality companies with strong capital positions and warranted pricing power. Companies with balance sheet flexibility and consistent cash flows are at an advantage over those reliant on looser financial conditions.

Additionally, with inflation still above the Fed’s 2% target, it remains unclear how persistent price pressures will be. We think it’s critical to focus on companies that have been creating incremental value for their customers over time and therefore have earned the right to raise prices to cover higher input costs and maintain profitability.

Where do you see attractive opportunities in equities?

While some pockets of equities appear overvalued, overall, multiples remain in a reasonable range, and attractive opportunities to buy high-quality companies exist. We are particularly interested in Artificial Intelligence (AI). The market appears to be crowning the AI “haves” and “have-nots,” but attention has been on a narrow set of industries and companies. We believe that the best companies across all industries will leverage AI to their benefit, and we are identifying opportunities where market misperception has led to a divergence in value for potential winners in this long-term theme.

What do you expect for markets over the rest of 2023?

We expect no-to-limited real economic growth in the remainder of 2023. But I am generally optimistic on earnings growth prospects. Recent improvements in labour participation could lead to an easing of labour cost inflation, and supply chain normalization and a return to more usual ordering and production patterns should be a tailwind. As costs continue to come down, companies are acutely focused on productivity via investment in technology. These factors could contribute to improved margins.

Certain industries have also already experienced a recession, with volumes down year-over-year. They could start to see replacement demand, as inventories and supply chains normalize, which could offset other industries entering a recessionary period.

Lastly, if we do see a material slowdown in demand, central banks now have dry powder to help stimulate growth again. It’s going to be bumpy, but I’m encouraged that we could see earnings growth over the next six to 12 months.

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