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Going forward, stretched valuations and more inflation may impact investor accounts.
As the world continues to emerge in fits and starts from the darkest days of the coronavirus pandemic, professional investors foresee a transformed investment landscape – with opportunities to make savvy financial moves.
“Because of events and developments that have happened during the pandemic, it is our take that we are not heading back to that world of December 2019,” says Chris Dillon, an investment specialist in T. Rowe Price’s multiasset division, who moderated an Oct. 19 panel at the Charles Schwab Impact 2021 virtual conference.
He added that factors affecting investment in a post-pandemic world will include less globalization, more inflation and stretched valuations.
On that last point, Dillon explains that according to T. Rowe Price’s calculations, an investor must hold an 85% allocation to equities in a globally diversified portfolio to achieve a 6% return.
That means investors’ portfolios must be structured more thoughtfully, with an eye on working harder to deliver the expected return.
In addition to these insights, experts at the Schwab conference addressed various headwinds and tail winds affecting investors, offering views on what’s ahead given pandemic- and inflation-related challenges.
What Advisors Should Watch in Emerging Markets
Interest rates are rising in Eastern Europe and other emerging markets, says Ernest Yeung, a Hong Kong-based portfolio manager at T. Rowe Price, who focuses on emerging markets and spoke at the Schwab Impact conference.
“In Russia, inflation is accelerating. In Thailand, inflation is accelerating. All these central banks are ready to raise rates,” he says.
Yeung contends that rising rates are not necessarily bad for emerging markets. If real rates in emerging markets turn positive, while real rates in the U.S. remain negative, the carry trade becomes more attractive. That could send more money from the U.S. and other developed nations into emerging markets.
Carry trade is a term for borrowing in a currency with a low interest rate, then converting the borrowed money into another currency, often with a higher rate. Proceeds may also be invested into stocks, bonds, commodities or some other asset class using the higher-rate currency.
Yeung adds that when inflation grows slowly in emerging markets, it can help drive increases in gross domestic product.
“It helps to restore some pricing power in the industrial supply chain,” he says. For that reason, these initial signs of inflation could bode well for emerging market stocks.
Schwab Impact panelist Sebastien Page, head of global multiasset at T. Rowe Price, says his group is eyeing big tech in emerging markets.
“One of our portfolio managers came to talk to the asset allocation committee last week and said, ‘Look at the growth side of emerging markets,'” he says, referring to tech. “It’s been beaten down so much that if you approach this with active management, you can have opportunities.”
Investors should consider overweighting companies playing a critical role in the build-out, maintenance and ongoing development of 5G networks, says Mitchell Rock, financial advisor at Ameriprise Financial in New York, in an interview.
“In addition, the pandemic most likely accelerated the shift towards factory automation and robotics,” he says.
“As the global economy returns its focus towards growth, companies in the technology sector should be in a good position to provide solutions,” Rock adds. [
Broad Sector Strength
Page says analysts on his team have been upgrading financials recently. He notes that earnings have been strong, and his team believes low interest rates are priced into the valuations of financial stocks.
“We also like small caps. We tend to look at the S&P 600, which is a cleaner version of small caps (and) higher quality,” he says. “It’s very cheap relative to large caps by historical standards, and if you buy the ‘slower, not derailed’ recovery narrative, then that makes sense over the next six to 18 months.”[
Page also put in a word for active management as a way to differentiate performance within asset classes such as small caps.
“The recovery should ultimately favor small caps because they’re more cyclical,” he says.
Utilities are also among sectors Page and his team are eyeing right now, based on income and cash-flow generation.
When it comes to fixed income, Page says some of T. Rowe Price’s managers are cautiously phasing in to Chinese bonds at low valuations.
“The credit story is good from a shorter-term tactical opportunity perspective,” he says, adding that active management is key in this regard. “I don’t want to do that with an index; you’ve got to know what you’re doing.”
Value vs. Growth
During the panel, Yeung noted that he’s a contrarian investor, meaning he’s looking to value stocks, which have underperformed for a decade.
Page added that global value stocks are about as cheap, relative to growth, as they’ve ever been.
“There’s an opportunity here to lean into value,” Page says. “We’re not making a huge bet, just leaning towards it.”
Page adds that investors are currently willing to take a long-term view on growth stocks, but it’s more difficult to have certainty about the next six to 12 months due to factors such as travel and interest rates.
Yeung cautions that value works differently in emerging markets than in the U.S. For example, in the past 10 years, domestic growth stocks solidly outperformed domestic value. However, in emerging markets, value outperformed growth in three of the past six years.
Yeung explains that in the U.S., a value stock tends to represent a beaten-down asset category, such as shopping malls.
“In emerging markets, most of the value stocks are not shopping malls in the middle of nowhere. They are domestic cyclical companies like banks or industrials or auto companies,” he says.
These companies benefit from the inherent structural growth premium of emerging markets, which over time, grow faster than developed markets.
“So even if you invest in the largest commercial bank in China, for example – and China is not growing very fast – the bank is growing loans in the low single digits,” Yeung says.
That type of investment can result in a good return.
Yeung adds that the style of Warren Buffett deep value investing tends not to work in emerging markets. That’s partly due to complex ownership structures that may include governments.
“You can’t just buy a stock and sit with it for 10 years hoping something will happen, and close that margin of safety,” Yeung says. “Cheap stocks in emerging markets stay cheap for a long time.”
Yeung says he and his team prefer to do a deep dive into emerging market countries and companies not getting a lot of attention to exploit inefficiencies. He looks at companies with little analyst research or institutional ownership.
“People don’t want to research these industries,” he says, adding that they just want to invest in Tencent Holdings (ticker: TCEHY) and Alibaba Group Holding Ltd. (BABA). “But for us, we see a pretty fertile hunting ground for active management.”
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