As global vaccination programmes gather pace following the onset of the Covid-19 pandemic, we have seen economies slowly emerging from states of lockdown.
Office blocks once empty on the back of stay-at-home orders, underground carriages with no commuters, abandoned theatres and suspended air travel are areas slowly but surely coming back to life. At the same time, it’s clear not all things will be going back to normal, as Covid-19 has accelerated trends at a very fast pace, be it a greater acceptance of working from home patterns, the fast adoption of technological innovations as well as vaccine/ medical breakthroughs.
What does this all mean for global equity markets?
Inflation is a critically important question for equity markets right now given it is resurgent and its knock-on impact on interest rates and asset prices. As we emerge out of lockdown, elements of demand that have been absent in the economy are resurgent and are meeting significant supply chain disruptions as a result of Covid-19. This is creating inflationary pressures in the near term.
The types of stocks that we would expect to do best in transitory or structural inflationary environments are very different, so it matters what is held within your portfolio. Long duration assets are generally far more sensitive (negatively) to any rise in bond yields and interest rates. There remains a high degree of uncertainty given that wage inflation – the key measure – is distorted when many governments continue to provide enhanced unemployment support, while cost inflation for goods is also distorted due to (possibly transitory) supply chain disruptions. We believe that our approach of investing in companies pursuing the right strategies for the opportunity set they are faced with, who have a significant element of control over their fate and an attractive valuation pay-off, is the right one.
What stocks do we like?
In order to reach global emission targets, we believe it’s imperative to embrace companies in the materials sector transitioning to more sustainable models within investment portfolios. Some investors shun carbon intensive sectors despite them taking significant steps towards cutting carbon emissions.
The mining sector is very intriguing but an area of great paradox. On one hand, mining companies are often vilified for their significant part to play in contributing to global carbon emissions but on the other, the raw materials they extract are of extremely high importance to society in terms of building houses, hospitals and other important infrastructure needed for daily life.
Anglo American – a leading diversified mining company – is a good example of a business facing material environmental risks and rewards. It has divested its legacy thermal coal assets which may well be impacted by fossil fuel transition and obsolescence risk but equally it produces large quantities of rare earth metals, essential for renewable and carbon capture technologies.
Another materials company we hold is the US company Steel Dynamics. It is among the leading steel producers and metal recyclers in the US. It has a number of ‘green’ plus points – 83% of its inputs are recycled and 77% of these are sourced within 250 miles of a mill, therefore reducing carbon footprints.
In a world awash with capital, we are also attracted to companies that can reinvest into their respective businesses at a high incremental return. An example of this is Constellation Software which acquires legacy software businesses across a wide range of sectors. It has a long history of success with this approach and the end market remains fragmented. Old Dominion Freight Line in the US moves consignments for commercial customers. They reinvest back into the business to maintain high levels of service through new and expanded facilities, extra trucks and trailers and IT. The volume of shipments has recovered sharply from the downturn in 2020 and the superior service levels offered are more valuable than ever to customers in a supply constrained world.
Time for Reflection
Covid-19 has brought home the challenges of a tightly networked globe and showed investors how a healthcare, societal or environmental issue can rattle the global economy to its very core.
The pandemic has brought into question – what in fact is the purpose of a company? Are they here to solely serve shareholders and yield profit, or should they pursue more altruistic endeavours such as reducing their carbon footprint? How will companies embrace the working from home model going forward? Can society fully embrace a new work life balance?
It’s going to take some more time to find out.
This article first appeared in FT Adviser, published on 27 September 2021.
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