2. Consider being “focused yet diversified” in the search for return
This year has continued to see mixed macroeconomic data and a wide range of potential outcomes, with many surprises along the way. Perhaps the biggest surprise of all has been in global stock markets, with the strong recent performance of cyclical stocks and the sharp rally in US mega-cap technology stocks. While mega-cap technology is likely to benefit from the rollout of AI-enhanced products and services, the rally in cyclical stocks is more difficult to explain.
However, in our view, earnings growth estimates are unlikely to remain in double-digit territory against an economic environment of slowing growth. Current earnings growth estimates are also at odds with the very high valuation multiples that many stocks demand — even though a deteriorating macro environment may challenge their growth prospects.
Against this backdrop, we believe it’s important to take a diversified approach to security selection, particularly within equities. Instead of relying heavily on cyclicals versus defensives or growth versus value, we believe there are attractive opportunities for alpha generation across a wide range of different asset classes that may be captured by active managers. In our view, investors who place a greater emphasis on security selection may be better positioned for the period ahead.
For example, as a result of capital expenditure in AI we are positive on both select cyclical opportunities in the information technology sector, where valuations still look attractive, as well as the US homebuilding sector, where we see a strong supply/demand imbalance for single-family homes. On the other hand, we also see attractive opportunities within defensive stocks that have attractive fundamental attributes and a low correlation to global equity markets in order to provide diversification benefits.
What does this mean for income investors?
- They may do well to avoid large portfolio factor biases.
- High-conviction opportunities that have complementary risk profiles may be beneficial.
- Focusing on risk metrics such as correlations during portfolio construction could be helpful.