22 September 2021 /
Our thinking
The cycle – where are we? Implications for global equity investors

Complex environments need active management to help steer portfolios in the right direction.

EISWERT_Dave.jpeg
David Eiswert
Portfolio Manager, Global Focused Growth Equity Strategy

Equity markets have continued to make gains despite concerns around the new delta variant of COVID‑19 as accelerated vaccine distribution has helped fuel expectations of a relative “return to normal.” Within equity markets, much debate centers on the future path of interest rates, inflation, and economic growth. Here, we analyze where we believe we are in this current cycle.

Asset prices are high for a reason

Asset prices are high because interest rates remain low, and there is no credit cycle to act as a disruptor. Both governments and central banks have proven to be a good backstop to a global pandemic that would have otherwise had much more severe consequences for financial markets without the unprecedented intervention taken. The outcome is that there appears to be little systematic risk if interest rates can stay at low levels and COVID‑19 slowly gets better. However, we are seeing ample examples of careless risk‑taking in financial markets. History suggests that this type of behavior should be actively managed within portfolios.

“Asset prices are high because interest rates remain low, and there is no credit cycle to act as a disruptor.”

“Absurd” inflation is likely to fall

We are witnessing “absurd” inflation in many areas of the economy, as well as general inflation in the labor market. We agree with the US Federal Reserve (Fed) that absurd inflation is transitory; lumber, DRAM,1 and used cars are pockets of absurd inflation we’d highlight. The question of whether labor inflation becomes embedded is still one to be resolved. While a degree of labor inflation is a good thing, an escalation would likely necessitate a change in monetary policy that could potentially disrupt the cycle.

We believe that demographics and technology, however, remain powerful structural forces that can continue to put downward pressure on long‑term inflation trends. These forces have not disappeared and should return as economies normalize.

Markets most afraid of Fed mistake and a rapid increase in interest rates

We believe that the market’s (asset prices) greatest fear is that absurd inflation might lead to a Fed mistake. Specifically, a rapid increase in interest rates that causes a crisis and a flattening, or even an inverted yield curve. In this scenario, the price of virtually all assets would fall – stocks, bonds, real estate, art, wine, etc. We had a preview of this type of move in December 2018.

In June 2021, we saw the market panic at moving Fed dot plots and the indication of tightening. Any hint of tapering or rising rates seemed to imply a “crisis” to a market that clearly requires easy monetary policy to maintain balance.

We are wary of the level of interest rates today and believe that the price of Treasuries represents hedging and risk aversion more than being an accurate indicator of future economics. We believe interest rates should be higher, but not so much higher on an absolute basis that it would imply a dangerous change in regime.

Many areas of growth investing appear crowded and full of momentum

The valuation of many growth assets increased significantly during the worst of the pandemic, and many of these valuation levels have been maintained, even as a path to relative normality has become clearer. Mega‑cap technology stocks have dethroned consumer staples and utilities as a source of market defensive positioning. We see significant crowding and momentum in some of these areas of growth, especially in SPACs, IPOs, and MEME2 stocks. We believe this is dangerous and requires prudence and active management to try to avoid significantly mispriced risk.

“Mega‑cap technology stocks have dethroned consumer staples and utilities as a source of market defensive positioning.”

Is “goldilocks” possible? The best path is slow normalization

We are increasingly leaning toward a “goldilocks” scenario where we see lower inflation (than today) but higher rates (although still historically low). This could potentially be driven by:

  1. A significant slowdown in the Chinese economy as reform and regulation are implemented when they can be (i.e., right now, during the current period of high economic growth).
  2. An acceleration in COVID-19 cases from the delta variant, which slows economic recovery.
  3. Continued progress in improving supply chain functions. The cure for high prices is high prices, as is often quoted.

Goldilocks implies that “absurd” inflation fades and economic growth stabilizes. We would expect to see lower inflation as more workers return to jobs and tight supply conditions ease. This has the potential to evolve into a good environment for stock pickers but one that is bad for crowded growth trades and pure speculators. A “normal” environment is less speculative.

“There are several segments of the portfolio where we are being carefully contrarian.”

Back to school and learning to “live with COVID-19”

The next big macro catalyst will be back to school in the US and whether this relieves the mismatch of labor supply and demand. American families with children have been a labor swing factor. If schools can stay open (enabling normal child‑care) while unemployment benefits roll off, we could see some normalization in labor supply and demand dynamics. This would be positive for risk because it points to the goldilocks scenario we mentioned above. The big question remains whether Americans (and the rest of the world) can adapt to “living with COVID” as opposed to a world without COVID‑19, which now looks very unlikely.

The bottom line for Global Focused Growth

We are comfortable with our portfolio, especially on a relative basis when compared with the barbells of growth and value factors. There are several segments of the portfolio where we are being carefully contrarian. We are searching for solid growth assets that are out of favor currently but where we see potentially higher growth in 2022 and beyond. This includes some travel‑related names. We also believe it is worth exploring China’s regulatory changes and the opportunities that it may create – albeit with prudence.  

We have talked previously about stocks that have “crossed the chasm” during COVID-19, and we continue to look for companies that have expanded their addressable markets and opportunities while looking to avoid the “imposters.”

As we move through this extraordinary period, we continue to focus our time on the hard and difficult choices required in these complex times. Our aim is to own stocks where we have an insight about improving economic returns while avoiding stocks that imply unnecessary risks and should be avoided. This is our role as fundamental bottom‑up stock pickers.

ID0004504 (09/2021)

202109-1822618

1 Dynamic random access memory (DRAM) is a type of semiconductor memory that is typically used for the data or program code needed by a computer processor to function.

2 Definitions: SPAC: A special purpose acquisition company is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company. MEME: Stocks that can have large and unpredictable price swings based on rumors and internet message‑board discussions. They are traded mostly by retail investors and tend to have a large social following. They are often stocks that are usually smaller, consumer-facing companies that are well known to many consumers.

Sign up for Global Equity insights from T. Rowe Price
Share this article:
Share on linkedin
Share on email

Important Information

The specific securities identified and described are for informational purposes only and do not represent recommendations.

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested. 

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction. 

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price. 

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

EEA ex-UK–Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.

Switzerland–Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.

© 2021 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

Our thinking
Multi-Asset_Solutions_EMEA_11_Jan_2021_600x600px
Insights

Weekly market recap

Read Time: 10 mins Yoram …

400-04276965_2000x1000px[62]
Our thinking

The cycle – where are we? Implications for global equity investors

Read Time: 5 mins David …

AdobeStock_42173823417_2000x1000px
Global Market Outlook

Gains still to be found in Chinese equities

Read Time: 6 mins Wenli …

Our global equity capabilities

Explore our range of strategies available to

you and your clients

Thank you for registering for global equities updates. The latest insights will be sent straight to your inbox, in the meantime see our latest thinking:

Important Legal Information

This site is intended for investment professionals. I have read, understood, and agreed to the terms and conditions detailed below and confirm that I am either an investment professional within the EEA or qualified investor within the meaning of Swiss collective investment schemes law with domicile in Switzerland, and that I will not pass on any information on this website or downloaded from this website to third parties.

Important Legal Information

By accessing this website, you consent to T. Rowe Price collecting information by way of cookies. To find out more please read our cookie policy.

Information contained in the T. Rowe Price website is not intended for investors in any jurisdiction in which distribution or purchase is not authorised, including the jurisdiction of the reader of this information, where applicable. For example, the information herein is not for distribution to and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States of America to or for the benefit of United States persons.

Information obtained from this site is intended specifically for the individuals who have agreed to these terms and conditions and may not be redistributed without prior consent from the T. Rowe Price Legal department.

The information on this website has been prepared for information purposes only and does neither constitute investment advice or other advertisement or recommendation nor an offer or solicitation to purchase or sell investment instruments, to effect any transaction or to enter into any legal relations. The investment instruments described may not be available to or suitable for all investors. You should consider, if appropriate, obtaining independent professional advice before making an investment decision and be aware of local laws governing investments.

For EEA

The information is designed for professional investors, including financial intermediaries or members of the media, and is published for informational purposes only. In particular, the information is directed at only informing persons falling within one or more of the following categories:

(a) A government;

(b) A bank or insurance company;

(c) A pension fund or charity;

(d) Persons whose ordinary activities involve them, as principal or as agent, in acquiring, holding, managing or disposing of investments for the purposes of a business carried on by them or whom it is reasonable to expect will, acquire, manage or dispose of investments for the purpose of such a business;

(e) Persons whose ordinary business involves the giving of advice, which may lead to another person
acquiring or disposing of an investment or refraining from so doing;

(f) Representatives of the media for corporate and background information about T. Rowe Price.

Persons who do not fall into one of the above categories should not act upon the information contained herein.

Unless otherwise noted, the content appearing in this Section of the T. Rowe Price website has been issued by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier.

For Switzerland

This website contains advertising.

The information in the T. Rowe Price website is exclusively directed at qualified investors within the meaning of the Federal Act on Collective Investment Schemes (‘CISA’) and its implementing ordinance as well as according to the most recent interpretation of the Swiss Financial Market Supervisory Authority FINMA with domicile in Switzerland.

In particular the following are considered qualified investors within the meaning of CISA: supervised financial intermediaries (e.g. banks, securities dealers, fund management companies), supervised insurance institutions, public entities and pension schemes with professional treasury management, enterprises with professional treasury management, high net worth individuals who have elected in writing to be deemed qualified investors and independent asset managers who have declared in writing that they will be using the information herein only for clients that are qualified investors.

Issued by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland.