According to VanEck, the volatility of markets falling and rising has been underpinned by “hopium” — i.e., these counter-trend rallies are based on the hope that the US Federal Reserve will reduce the size of the rate rises. The firm noted that finding value in 2023 looks to be more challenging.
Cameron McCormack, portfolio manager at VanEck, said, “We believe the ‘quality’ factor will be dominant and, over the long term, persistent across the cycle.
“US headline and core inflation have started to fall but services inflation remains sticky. Services inflation contributes 60 per cent to total CPI and high accelerating year-on-year growth is a function of high wage growth and record-low unemployment. US ISM Services PMI print for November this week came in much higher than expected at 56.5, further illustrating the tight labour market.”
He added that an increase in the US unemployment rate is likely in order to lower wage growth, spending and cost inflationary pressures.
“Historically though, every time the US unemployment rate has increased by more than 0.50 per cent, it has resulted in a recession,” Mr McCormack said.
“Based on the current inversion of the curve, as reflected by the 10 and two-year yields, a US recession is priced in as a probable scenario in late 2023, especially given the rapid succession of central bank policy rate hikes and the Fed’s apparent commitment to curb inflation.
“A slowing economy, with falling inflation, could see the quality factor come to the fore. In the past, in this type of macro environment, companies with strong balance sheets, stable earnings and high return on equity, all quality characteristics, have outperformed.”
Quality companies typically trade at a valuation premium relative to the benchmark, VanEck said, which means that prices are more sensitive to interest rate movements.
With stable earnings, the investment manager added, quality companies typically outperform in a late-cycle environment as they are rewarded for their ability to generate sustainable earnings amid a backdrop of static economic growth.
“Quality was the standout factor between the global financial crisis and emergence of COVID-19 during an era of falling inflation and [stagnant] economic growth. The stage is set for a repeat of this environment in 2023 and we expect the quality factor to outperform,” said McCormack.
