Navigating Market Volatility
Navigating Market Volatility
What are the key themes likely to shape markets in 2019?
I think the key themes of 2019 will be trade policies and, more broadly, whether those policies are indicative of changes in geopolitics. Tariffs with China are one thing; it is another thing if the U.S. disentangles from one of its biggest strategic trading partners. I think understanding the nuance of this potentially new dynamic and the impact to supply chains, cost structures and corporate profitability is important.
Interest rates will likely be another significant theme. Already, we’ve seen higher rates weigh on rate-sensitive areas of the economy. The rate moves have also negatively affected some of the market’s most expensive stocks, whose future cash flows tend to be discounted the farthest into the future. Together, these trends suggest equity markets could face a less-friendly backdrop in 2019 than they have in recent years.
Where do you see the most important opportunities and risks within your asset class?
Companies with less competitive differentiation and lower operating margins could face more challenges in 2019. With an undifferentiated product, these firms could find it difficult to pass on tariff- or inflation-related cost increases. Businesses with fragile balance sheets could also face pressures. If we see higher interest rates and a slowdown in economic growth, the margin of error for these companies is slim.
As for opportunities, I think businesses that are relatively insulated from current macroeconomic and interest rate pressures but don’t have the exceptional valuations of many “have” stocks – companies perceived as being tied to exciting secular growth themes – could be well positioned. Today, that bucket tends to include growth cyclical companies. By growth cyclicals, we mean firms with the potential to be share gainers: Companies that, from one business cycle to the next, actually acquire market share. So these firms emerge from a cycle stronger, bigger and, potentially, more profitable.
How have your experiences in 2018 shifted your approach or outlook for 2019?
For a long time, we’ve talked about finding companies with stable earnings growth, good management teams, strong balance sheets and reasonable valuations. In a world where markets compounded 15% a year and interest rates were falling, some of those virtues went overlooked. In that environment, companies with vulnerable balance sheets could still thrive, or momentum could help carry high-multiple stocks to even loftier valuations. For 2019, we think a disciplined investment process focused on high-quality growth will be essential. To that end, we are looking for companies that we believe have sustainable competitive advantages and pricing power. We also want companies that are generating a high return on capital and, therefore, don’t need to take on debt to grow.
"Tariffs with China are one thing; it is another thing if the U.S. disentangles from one of its biggest strategic trading partners. I think understanding the nuance of this potentially new dynamic and the impact to supply chains, cost structures and corporate profitability is important." – Brian Demain, CFA, Portfolio Manager
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