Seize the opportunities in a new era for global equities

In 2023, investors have had to contend with multiple headwinds that could have combined to derail equity markets. Among them, a regional banking crisis in the U.S., a severe slowdown in China, and wars going on in Ukraine and the Middle East. Add to that 500 basis points of cumulative interest rate increases, a deeply inverted yield curve, and a litany of other gloomy economic indicators. Yet, while there have been bouts of volatility, equity markets have held up surprisingly well. Large‑cap technology companies—in particular the so‑called Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta Platforms, and Tesla)—have fared even better. 

What’s behind the apparent contradiction? In the U.S., economic growth has consistently exceeded expectations, pushing out a highly anticipated recession. We also haven’t experienced a “normal” credit cycle. In the U.S., companies and consumers alike have termed out their debt over the last few years at extremely low levels of interest rates. Fiscal policy, meanwhile, has bolstered the economy through infrastructure spending, in numerous cases for geopolitical considerations, and in stimulus measures to help during the coronavirus pandemic. Consumers have reaped the rewards of higher savings and accelerated real wage gains, while at the same time locking in low rates on their largest expense—mortgages. Simply put, the Fed rate hikes have been nonbinding and haven’t impeded the economy in a material way. How long this will last is an entirely different question, but it is how we got here today. 

A new equilibrium path for equities?

Our view is that we are operating in a different environment from the one that supported equities for much of the period after the global financial crisis. The equilibrium path has changed—and equity investors need to adapt. 

Between the global financial crisis through to the coronavirus pandemic, the equilibrium path was deflationary—low inflation created even lower inflation. This was demonstrated in the energy sector as the low cost of capital and technological revolution of fracking led to increased drilling and more oil being sold at lower prices. A cycle of lower inflation and lower rates created a continuous feedback loop of abundance. The dynamic was not isolated to the oil and gas industry. It extended across sectors and economies and created a paradise for growth investing—especially for those investing in duration.

The cycle has shifted, and we now appear on a new equilibrium path. One where we see inflation remain sticky, despite recent falls, and with interest rates being maintained at higher levels for longer. The global financial crisis shocked us onto a lower inflation and lower rate path. Now, the pandemic, fiscal policy response, and supply chain problems have shocked us onto this new path—one that is likely to lead to a continuous feedback loop of scarcity.

Again, we highlight the oil and gas industry, where even though oil prices have risen solidly since the summer 2023 trough, rig counts in the U.S. are falling. Why? Because rising financing costs; labor shortages; higher transportation costs; environmental, social, and governance (ESG) pressures; and industry consolidation have all pushed the oil cost curve meaningfully higher. This requires oil prices to be higher to incentivize companies to accelerate drilling. 

These dynamics set the scene for inflation to remain sticky, alongside higher interest rates, until we get shocked off this path. This would require a recession and high unemployment, but that is not predicted in the near term. With the U.S. Federal Reserve unable to create a credit cycle, but also unlikely to aggressively cut rates leading into an election year, we expect higher short‑term rates for longer until the excess liquidity from the pandemic is pulled out of the system. 

 

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