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Fabiana Fedeli
 CIO, Equities, Multi Asset & Sustainability 

19 min read

Key takeaways:

  • We do not believe the backdrop lends itself to either trying to time the market with short-term trading or taking broad index exposure.
  • Equity performance is broadening and stock-specific drivers are coming to the fore – this year, stocks that have beaten expectations and successfully delivered innovation have outperformed.
  • We believe investors need to dig deeper and broaden their search to discover those hidden gems of innovation that are delivering differentiated products and solutions across the globe.

Contents

With rates most likely having reached a peak and a resilient growth backdrop, we think equity markets are still a good place for investors to put capital to work, particularly if you consider the approximate $6 trillion1 parked in money market funds globally2, part of which we expect to see flowing back into risk assets once interest rates eventually start to decline. That said, with potential volatility coming from macroeconomic and geopolitical news, and some areas of equity markets having performed strongly over the past year, we do not believe the backdrop lends itself to either trying to time the market with short-term trading or taking broad index exposure.

Timing of rate cuts

Firstly, while it is likely that we are at peak rates (with the ECB having just cut by 25 bps), the timing of cuts is uncertain and difficult to gauge. The US Federal Reserve (Fed) itself is data dependent and even it doesn’t seem to know when the next cut will come. Looking ahead, it will be important to see how the labour market, consumption and core inflation data develop. While core inflation remains stubbornly sticky, we are close enough to that 2% target that the Fed could consider cutting rates should the economy take a turn for the worse. 

That said, for now, there are no signs that a rate cut is either imminent or necessary. With real rates as high as they are now, we should expect some further slowdown in the US economy – although a recession in the US doesn’t appear in the cards for this year at least – hence, we could see one or two cuts before year end. Importantly, one rate cut will not necessarily mean a sequence of cuts will immediately follow as central banks, particularly the Fed, may decide to pause after the first one to assess the impact.

It’s also worth keeping an eye on US state-level job data, which may offer more clues than the country-wide data. One thing that we know, as does the Fed, is that – once unemployment starts to tick up – the job market can unravel at pace. Two states (California and Nevada) and the district of Washington DC are currently sitting with over 5% unemployment3. Again, no reason for panic, but reason enough to keep a watchful eye.
 

Stock-specific markets

Secondly, on equity index investing: after a strong overall performance, the market is broadening and becoming more stock specific. We continued to see this in the recent earnings season where, even within the same sectors, there were companies able to stand out and differentiate themselves, while others were left behind – observable with companies that, for example, have not invested in product innovation. 

Importantly, consumers are becoming increasingly discerning with their purchases, sometimes trading down, but certainly being more selective about what they are willing to spend their money on. For instance, during the recent earnings season we learned that high-spec trucks were all the rage in the US, beauty products…not so much.

The Magnificent Seven (Mag 7)5 were credited with lifting S&P 500 gains in 2023, given their outsized weight in the index – despite only two of the seven making it into the Top 10 performers in the MSCI AC World Index in 2023. By the same token even a small underperformance can have the opposite effect, dragging the US indices down. We witnessed the impact of these drawdowns in January and April this year, leaving the S&P 500 and Nasdaq trailing other market indices year-to-date.

Interestingly, of the Mag 7 only Nvidia is among, not only the top 10 but also the top 40, best performing stocks in the world year to date:

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Wherever mentioned, past performance is not a guide to future performance.

The views expressed in this document should not be taken as a recommendation, advice or forecast and they should not be considered as a recommendation to purchase or sell any particular security.

Selectivity in technology

And speaking about technology, this is one area where selectivity has proven crucial to investment returns this year. We are witnessing a changing-of-the-guard moment. During the last earnings season, overall we saw softer results from tech companies exposed to legacy products. With tighter money supply and worries about the economy, spending on older products has been challenging and corporates are making choices (just as consumers are), and preferring to spend on Artificial Intelligence (AI).

For some companies that benefit from AI-related sales, however, the increased spending on AI is not able to offset the decline in their legacy business. We are at a juncture here where, despite the upside potential for some companies that are able to access significant AI-related growth opportunities, the same companies’ legacy businesses have the potential to drag on some of the benefits of that exposure. Hence, it is important to understand all of the drivers of a company’s business, no matter how innovative they are on the AI front. This is a typical dilemma when we have a disruptive change in the market.

Innovation driving price performance

For many market participants, the biggest surprise of the first half of 2024 has been the outperformance of equities versus fixed income markets. This is similar to what we experienced in 2023. In H1 2024, equity markets have defied the higher-for-longer fears and delivered solid returns, with the MSCI AC World Index up 8.5% as of 3 June 20244. The reasons are clear and, more importantly, the most recent earnings season has charted the path for what could come in the remainder of 2024.

In our view, there were two key drivers of positive price performance: a beat of expectations and the successful delivery of innovation. The outperformance of European and Chinese stocks was one example of expectations having become too pessimistic, while the dispersion in results from companies in the same sector, even within US technology, has been driven by companies on the right side of innovation trends and their ability to deliver.

In cases where undemanding expectations met with the power to innovate, this created some of the strongest outperformance. Going forward, this will continue to be among the best hunting grounds for the creation of alpha, in our view, with opportunities deriving from investors’ tendency to converge around a narrower set of brand names.

Broadening the search for innovation opportunities

We firmly believe in the power of innovation as a driver of business and investment returns, However, the valuations of many companies at the forefront of innovation have seen a spectacular rise over the past year. Some may still warrant further upside, but others may be due a pause for business fundamentals to catch up with investors’ excitement.

This, however, does not mean that the equity market has exhausted its opportunities. To harness the transformative potential of innovation and new technologies from here, we believe investors need to look beyond the ‘headliners’, and seek opportunities across the wider market; across sectors and geographies. In a nutshell, we need to dig deeper and broaden our search.

While, in the US, Nvidia has been the poster child for tech innovation, and an eye-catching success story, there are many less visible pioneers and innovative companies globally that are offering differentiated products and solutions, and creating a competitive edge for themselves.

In truth, some of the most innovative companies are hiding in plain sight. These may be large multinational conglomerates, where the complexity of their operations means that it can often be a challenge to identify the key business drivers. Siemens, for example, which has traditionally been considered a large industrial manufacturing company, has quietly transformed its factory automation business into an industrial software and productivity colossus.

Japan is a rich, if underappreciated, source of innovative companies that are dominating in their respective fields. The country’s largest telecommunications firm NTT is also the world’s third largest data centre owner, and at the forefront of cutting-edge ‘photonics’ technology, based on light waves. As data creation and transmission increases exponentially, particularly as the use of AI becomes more ubiquitous, the processing of information using the company’s optical technologies has the potential to increase energy efficiency by a factor of 100 (as well as increasing transmission capacity by a factor of 125 and reducing latency by a factor of 200)6.

When we think about the wider physical infrastructure required to power this digital revolution, we will also require greater renewable energy capacity to meet our power generation needs. Top of mind are companies with a dominant market share developing large wind and solar farms, but less frequently mentioned are the material sciences companies like Japan’s Toray, providing advanced composite materials and components to support the roll-out of these projects. The Japanese company provides approximately 50% of the global composite material used to manufacture wind blades, along with the cutting edge carbon fibre used in aircraft – creating lighter, more fuel-efficient vehicles7.

And while all eyes are on the technology rift between the US and China, some Chinese companies are quietly innovating in less newsworthy areas of the market. In the consumer sector, we are seeing apparel retailers seeking to strengthen ties with innovative original equipment manufacturers (OEMs). For example, as sporting goods companies seek to compete on the strengths of their more technical product offering, they are increasingly turning to, and valuing, the OEMs with the strongest offer in terms of fabric and product development.

Hong Kong-based Crystal, for instance, provides technical materials to the likes of Uniqlo and Lululemon. The OEMs are increasingly focusing on sustainable materials, production techniques and supply-chain traceability to improve market share, with the likes of Crystal increasingly leveraging large language models (LLMs) and Generative AI (GenAI) to improve efficiencies throughout the value chain.

We can even still find hidden gems among technology stocks, where many of the headline AI names have seen staggering price rises. For example, software solutions company SAP, headquartered in Germany, is embedding AI in its software product and using AI to enhance its research and development (R&D) efforts. And, as demand for cloud services continues to grow, SAP’s transition of its core enterprise solutions business to the cloud is moving in lock-step with this trend. In our view, the company’s prominent position in enterprise software, value-enhancing AI initiatives, steady core business (with more than 70% recurring revenues in most of its software end segments), and ongoing commitment to innovation and improved client experience, could set SAP on course to drive solid growth over the coming years.

There are more hidden gems across industries, including many that are starting to emerge in the financial and healthcare sectors. If we go by recent earnings season results, with consumers and corporates making increasingly deliberate choices about where to spend, companies that are not only meeting their customers’ current needs but also improving their products and services to meet their future needs, have been able to beat market expectations and grow – even with the backdrop of higher-for-longer rates. To find them, we just need to dig deeper and broaden our search.


[1] US Dollars
[2] Source: Bloomberg Intelligence, 28 May 2024
[3] Source: US Bureau of Labour Statistics, Unemployment Rates for States (bls.gov), 17 May 2024. Data for April 2024.
[4] The so-called Magnificent 7 are large US stocks, Apple, Microsoft, Alphabet, Amazon.com, Nvidia, Tesla and Meta Platforms.
[5] LSEG Refinitiv, price returns in US dollars, 4 June 2024
[6] Source: NTT website, Innovating a Sustainable Future for People and Planet NTT R&D Initiatives | NTT Technical Review (ntt-review.jp)

[7] Source: M&G Investments, Toray, 2023 (communicated in meetings with company management).

An inflection point for emerging market equities?

Michael Bourke

Emerging Market Equities Fund Manager

Emerging markets (EM) have faced their fair share of challenges this year (and for the last decade), with the strength of the US dollar, for one, posing a significant hurdle. However, amid this backdrop, EM has witnessed encouraging developments which could capture investors' attention and offer compelling opportunities. 

China

Chinese equities have rebounded from their lows in January after valuations became extremely  depressed. This recovery can be attributed to a combination of factors, including the introduction of government stimulus measures and stock market reforms, improving economic indicators, as well as growing consumer demand. 

As China continues to chart its course towards economic stability, we see investors cautiously embracing the move by Chinese corporates to increasingly focus on returns on capital over growth at all costs. As bottom-up stock pickers, we are excited about the opportunities, but will remain vigilant in a market that is volatile and often trades on sentiment rather than fundamentals. If we witness a recovery in earnings over the upcoming quarters, we hope a fundamental-driven approach will take hold in China once more.
 

South Korea

The South Korean stock market has traded up strongly this year, driven by corporate reform expectations that followed the announcement of the ‘Value-up’ programme which launched in June. South Korean companies often trade at lower valuations than their global peers due to a weak corporate governance record, poor returns on capital, and geopolitical challenges with its northern neighbour.

To address the so-called 'Korea discount', regulators are taking cues from their Japanese counterparts and urging companies to establish plans and targets aimed at enhancing shareholder value. We believe these measures have the potential to reshape the investment landscape and unlock new opportunities in the market. The early signs have been promising, in our opinion, and we anticipate a more comprehensive understanding of the programme’s impact to emerge over the rest of the year.

Promising signs ahead?

Emerging markets still offer enticing growth prospects, in our view; however, the search for value creation amid these growth engines is what we look for. There are encouraging signs as corporates in large economies like China and Korea are increasingly beginning to understand this dynamic. We believe the next cycle could be dominated by Asian and broader EM companies delivering higher returns on capital. 

2024 potentially represents an exciting inflection point because the asset class is still attractively valued, the end of the dollar rate cycle appears to be looming large and we believe geopolitical concerns are already reflected in share prices, particularly in China. 

Value investing is still alive in Europe

Richard Halle

European Value Equities Fund Manager

Value investing appears to have fallen out of favour in recent years, most notably in the US, where investors have shifted towards growth stocks. However, the style headwinds in the US have overshadowed the resilience of value in other regions such as Europe. 

As dedicated European value investors, we believe the prospects for this long-unloved asset class are extremely promising. For a start, we see a market backdrop that has changed considerably since the pre-Covid era. Instead of a world defined by long-running trends of stability and predictability, where investors could thrive without caring about fundamental valuations, we are now in a world subject to increased volatility, disruption and surprises.

Recent examples of instability include the banking crisis in the US (and its subsequent contagion to Europe); macroeconomic worries; and the impact of rising bond yields on equity ‘bond proxies’. All of these have created opportunities for us as contrarian value investors. We believe this world of unpredictability will persist, and being in a position to take advantage of mispriced stocks could lead to good alpha opportunities.

Another positive aspect, in our view, is that the European equity market is two-tiered. Valuations of quality growth stocks reached elevated levels during the zero-interest rate environment. The big-name growth stocks have also benefited from passive investors and global investor interest. In contrast, the cheaper part of the market has been overlooked and remains attractively valued, in our view. As a result, the valuation dispersion in Europe is among its widest ever levels.

In a world where valuations of out-of-favour value stocks look attractive and different trends have emerged within the investment regime, we believe different stocks could do well compared to what has led markets previously. Today’s value stock may be tomorrow’s growth stock, for example. We are seeing cases where this is already happening. Over time, we remain optimistic that investors will look more favourably on value stocks and pay more for companies that were better than they originally thought.

Capturing the power of global dividend growth 

Stuart Rhodes

Global Dividend Fund Manager 

Dividend investors have experienced headwinds over the past couple of years. The emergence of AI as a major theme has led to a very narrow market, driven mainly by US technology and ‘new economy’ mega-cap stocks, many of which do not pay dividends.

This has been compounded by the underperformance of traditional defensive areas like consumer staples, utilities and healthcare in a higher interest rate environment. However, the prospect of rate cuts in the coming months could be helpful for dividend-paying stocks and create a powerful tailwind for the strategy.

Encouragingly, today, we are potentially seeing better value in the out-of-favour consumer staples and healthcare sectors than we’ve been used to in recent years. The severity of the declines in some areas is creating attractive entry points, in our view, for some companies with decades-long track records of paying a growing dividend. This is very important because we believe most of the long-term successful track records within dividend investing have a focus on growth.

Not only does a growing dividend provide a defence against the corrosive effects of inflation, it can put pressure on the share price to move up alongside the dividend.

Dividend investing is not simply restricted to defensive companies. It is possible, albeit harder, to find companies that are growing quickly and pay rising dividends at the same time. We would highlight the surprise decision by Facebook owner Meta Platforms to start paying a dividend this year as a great example of the broad range of dividend opportunities.

Although Meta’s prospective dividend yield is less than 0.5%1, we see a long runway for that dividend to get a lot bigger in the future, and it could represent the start of an interesting trend among technology and new economy companies to incorporate dividends as part of their cash returns to shareholders.

After a challenging time for dividend investing, we are encouraged by the wide range of opportunities we are finding and the developments unfolding in the market. We think the headwinds we currently face with a narrow US equity market are likely to dissipate in time and, therefore, from a longer term perspective we feel optimistic about the future.

We remain resolutely focused on dividend growth as a compelling strategy over the long term, without losing sight of the reality that the global economy faces challenging times ahead. Dividend cuts will be inevitable for companies not equipped with the financial armoury to withstand a cyclical downturn. Balance sheet strength is a key consideration in our company research to ensure that dividends can be sustained in the current climate.

[1] Source: Morningstar, Meta's First Dividend Explained,  Feb 2024

Spotlight on listed infrastructure 

Alex Araujo

Global Listed Infrastructure Fund Manager

There is no question that the recent macroeconomic backdrop has been unfavourable for listed infrastructure. In a world where investors have chased more “exciting” technology stocks and penalised dividend-paying stocks, the asset class has encountered headwinds.

Listed infrastructure tends to have a large allocation to the utilities and real estate sectors, both of which are perceived to be interest sensitive. The market narrative around ‘higher for longer’ interest rates has been challenging but with inflation moving in the right direction, and recent rate cuts in Europe (and potentially more on the horizon in the US), we are optimistic about the outlook for infrastructure investing.

We see attractive valuations across the asset class currently. One area that is compelling, in our view, is utilities where valuations remain at near record low absolute and relative levels. Simply by virtue of being dividend-paying stocks they have been punished by the market, despite the sector continuing to deliver consistent earnings growth and higher dividends.

Another sector that has been caught up in this trend is companies structured as real estate investment trusts (REITs). These companies have real assets at their core and those with robust and growing earnings are very attractive, in our view. The REITs we hold are not in structurally-challenged areas such as offices or retail. We have invested in data towers, data centres and logistics warehouse operators, which continue to demonstrate strong growth fuelled by the inexorable demand for digital communications and the evolution of artificial intelligence (AI).

Infrastructure could play a critical role in supporting our digital future in other ways too, for instance by providing the power sources and grid networks needed to meet increased demand for data and power. 

While we wait patiently for the macroeconomic backdrop to shift, we see companies continuing to grow their dividends, offering an income that helps offset and protect against inflation. With attractive valuations, the potential for compounding income growth and access to powerful structural trends, we believe the outlook for listed infrastructure is promising.

Addressing the income challenge 

Stefano Amato

Multi-Asset Fund Manager

Income is king, especially in an environment of persistently higher prices. But how to address the income challenge without sacrificing growth, the irreplaceable ingredient for satisfactory investment outcomes over the long run?

We believe that the answer lies in a combination of disciplined adherence to evergreen investment principles and an active approach to tactical asset allocation.

On one hand, in our multi asset income funds we purposefully aim to diversify sources of returns and income generation across a broad range of asset classes. This can allow us to build robust portfolios that can benefit from medium-term asset appreciation but are also able to withstand unforeseen economic shocks.

In the current environment, this translates into a well-diversified approach to income generation across asset classes which – as per the chart below – also features dynamic shifts as we react to new investment opportunities that arise over time.

Additionally, we actively monitor global markets with the aim of harvesting tactical investment opportunities when we can spot attractive fundamentals, unusual price action and extremes in investor beliefs as per our ‘patient opportunism’ philosophy.

A recent example of this would be our choice to buy Chinese equities in January, when they were lowly valued and we could observe many signs of antipathy among investors.

Presently, our confidence in the potential to deliver both income and growth is partially restored as we observe tentative signs of decoupling between equities and bonds.

At prevailing yields, bonds already provide a meaningful contribution to the strategy’s income. If their ability to provide portfolio insurance is even only partially restored – as policymakers now have a lot of ‘dry powder’ to counteract any growth shocks – we can then have more (guarded) confidence in pursuing opportunities in the equities space, therefore retaining exposure to potential growth appreciation over time.

A combination of robust diversification plus ‘patient opportunism’ should therefore serve investors well, potentially enabling the generation of meaningful levels of income without sacrificing prospects for capital growth.

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