Speaking at the Morningstar Investment Conference 2024 in Sydney last week, the portfolio manager for the T. Rowe Price Global Equity Fund argued markets are becoming “obsessed” with quality, having enjoyed a decade of “happy days.”
“The last 10-15 years was the golden era for corporate profits. We had a world where interest rates were low on your debt. Tax rates were low. Companies, countries, regions were competing for it. Global supply chains, no commodity inflation, little labour inflation, peaceful world, it was happy days,” he said.
“And so, in that era, there were times when rising tides notionally could lift all boats, and it wasn’t totally irrational for someone who didn’t love quality, they could say ‘look, I’m not just quality value, but I’m value value, and we’re in a world that’s going up and I’m going to participate.’ That world has kind of ended.”
The current world, Berg highlighted, is marred by higher interest rates on corporate debt, increased tax rates on most companies, the reshoring and onshoring of operations, commodity and labour inflation, and the added burden of decarbonisation and green energy costs.
“We’re now in a world where corporate profits aren’t going to grow quite as much,” he elaborated.
“There’s more uncertainty and there’s more risk. So in a way, I think being in the good stuff, quality kind of matters more. That rising tide isn’t going to help everyone as much, and then it just comes down to how much quality you have, how much you’re willing to pay for it, and how you define it.”
What matters this year
Reflecting on the past four years, Berg described them as a “crazy rollercoaster” during which people’s outlooks swung from pessimism to optimism within just a few months.
Berg referred to 2023 specifically as the “best global equity year in 20 years.”
“Last year we had a year where rates went up, not down, earnings growth was zero, China blew up and geopolitics got complicated. It was the best global equity year in 20 years,” he elaborated.
Looking at 2024, Berg’s key dimensions for the year include the economy, geopolitics, and generative AI.
“The first bucket of what matters is economy, rates, fundamentals. My simple summary is, the US economy is proving far more resilient than I thought, than the Fed thought, than most thought and it looks quite unlikely we’re going to have a recession in the US… The impact of that is you’re not going to get as many rate cuts as we thought,” he said.
On valuations, he argued markets had “found a new baseline” after five or six quarters of nearly no earnings growth globally.
“If you think about going through a crazy COVID period, not knowing when you come out of it, where earnings end up, and with higher rates and war and inflation, it feels like we’ve found a new baseline and we’re growing. Now, the growth of that isn’t quite as good as it used to be, it’s going to be more challenging, but we’re growing,” Berg explained.
The US particularly was getting a little frothy, he observed, with pockets of bubbles in semiconductors and certain AI stocks.
He also reflected on how markets remained focused on the upcoming US elections, though he remarked neither candidate “would likely qualify for any corporate board in Australia or America.”
“But on the positive side, they’ve both been president, and how sorry are you for owning US stocks for the last eight years while these two jokers were in charge?” Berg said.
“In a way, sometimes I think people over-index to elections, and the strength of the US system is that either one who wins inherits a divided Congress.”
However, US fiscal debt was something being closely monitored, he conceded, and will likely come to the fore with a recession, though it has been pushed further down the road for now.
On AI, he argued the technology is still in the investment phase, with huge amounts of money currently being devoted to purchasing GPUs and setting up data centres.
“Even five months into the year, the seven biggest companies in the world have raised their capex estimates by another 30 per cent, so we’re not really at the point now where they’re going to have to prove out these businesses. This is just building the infrastructure,” he said.
An ideal portfolio, Berg remarked, would constitute a combination of these considerations.
“I think of my portfolio construction as 60 per cent true bottom-up, fundamental bottom-up, 20 per cent thematic bottom-up, and then a 20 per cent top-down awareness of what’s happening in the world,” he said.
He also described the firm’s positioning in 2024 as “a little more balanced” than it has normally been over a 15-year span in recognition that “things look a little fuller and there are a little more risks.”
“But we’re still fully invested, not defensive – just not as aggressive on the margin, as we’d normally be a little more aggressive,” he said.
