By Martyn Hole, equity investment director at Capital Group
As the curtain draws on the first half of 2022, investors continue to face new risks as the market remains in a state of flux. For investors, maintaining an all-weather portfolio makes sense in any environment but particularly this one.
With a bottom-up fundamentals focussed approach for identifying companies that can generate strong earnings growth, we believe that the future still looks positive for long-term investors. Although the world is dramatically changing, for the selective investor, opportunities abound and here are just 10 themes for investors to consider for their portfolios.
We believe inflation will linger in the months ahead, making it one of the biggest risks investors face for the rest of 2022. As such we are focused on uncovering companies with pricing power that can protect their profit margins by passing those costs along to customers.
Companies with pricing power potentially include consumer businesses with strong brand recognition, like beverage makers Keurig Dr Pepper and Coca-Cola; companies in the fast-growing video games segment, like Microsoft and Tencent; and companies providing essential services, like Pfizer and UnitedHealth.
Tech trifecta – semiconductors, cloud computing and software
First, if pricing power is the key to fighting inflation, then the semiconductor industry is in a strong position as we see no end to the world’s appetite for semiconductors. Second, semiconductors are the backbone cloud technology companies use to power their business. We believe we are still in the early innings of the cloud transition. Finally, if chips are the backbone of the cloud, then software is the brains. Today, software is driving advancements not only in e-commerce and finance but also healthcare, education, transportation, construction and agriculture. The scope for tech should not be overlooked.
Companies are shifting from dividend zeros to dividend heroes. Particularly in Europe, companies suspended dividends during the pandemic primarily due to political or regulatory pressure, but now many of them have surplus capital to redeploy as regular and catch-up dividends. We are focused on companies with strong underlying earnings growth that have demonstrated a commitment to raising their dividends over time.
With recent advancements in genomic and proteomic analysis and the launch of many new modalities of drugs, we believe the breakneck speed at which life-changing drugs are being approved and developed will continue. Today we have new therapies designed to engineer how the body recognises and treats disease itself. These treatments have the potential to extend lives and generate billions of dollars in revenue for companies that are able to develop them successfully.
The adoption curve of electric vehicles (EVs) has steepened thanks in large part to government incentives and tighter emissions standards for gas-burning cars, particularly in China and Europe. Although EVs are on the threshold of profitability, some will likely get there sooner than others. Tesla has been a clear leader, having briefly surpassed a market cap of $1 trillion (£842bn) in 2021. Companies quick to embrace structural change and rapidly adapt have a better chance of success over the long term, whether they are industry titans or start-ups.
Selectivity with China
Risks to investing in China have risen due to macro and regulatory issues. However, we believe there are still compelling long-term, secular growth trends that make the country an attractive market on a stock-by-stock basis.
China is positioned to dominate the global manufacturing supply chain for EVs and decarbonisation solutions such as solar panels. Chinese manufacturers are producing high value-add parts at scale, including servo motors, electric drive trains and thermo management systems. A fast-growing home market for EVs is supportive of the supply chain development. China is already a dominating force in solar panel manufacturing, and it is increasingly leading in specific components such as inverters.
This January, three blockbuster deals announced over a matter of days highlighted the swift change of pace in the industry. If all three are finalised — Microsoft’s bid for gaming giant Activision Blizzard among them — it would amount to more than $90 billion in M&A activity centred on video games, the fastest-growing segment of the media sector.
Driven in part by a pandemic-era gaming boom, the media landscape is fundamentally transforming the way people communicate and entertain themselves, and this makes interactive games all the more valuable to the likes of Microsoft, Sony and many others.
Future of financials
Today, the financials sector encompasses a broader set of opportunities than traditional banks and insurers. Among these are exchanges, data providers and asset managers. To invest successfully in financials, it can help to look closely at each of these companies to understand what assets they own and where those offerings fit into the business cycle.
We don’t think of ESG as just an exclusion process. We think of it as identifying companies that are doing the right thing and supporting those in transition. This extends far beyond the energy sector. For example, buildings pump more carbon dioxide into the atmosphere than the entire transport industry. One of the most effective ways to reduce greenhouse gas emissions is to improve air conditioning and heating efficiency. Regulations that require the replacement of older systems with more energy-efficient products in Europe and elsewhere could underpin a long-term tailwind for HVAC companies like Daikin and Carrier.
Flexible fixed income
High inflation is cooling bond returns, and speculation about the Federal Reserve’s path and pace of interest rate hikes has pressured bond prices. The good news however is that the economy is doing well, people have jobs and cash — and they want to spend it. What’s more, many companies have strong balance sheets and are positioned for growth.
The underlying strength in the economy, and the shorter interest duration in high yield and securitised debt have made those sectors attractive. A flexible, diversified approach to allocating among these different sectors based on market conditions and investment insights could help create a more resilient income and return stream for investors.
Today’s challenging environment is causing increased market volatility. However, history has shown that markets have recovered from past periods of geopolitical and economic market shocks. It is important for investors to remember that markets over the long-term have been resilient and have powered through many challenges. Now is the time to evaluate one’s portfolio, stay focused and make a play for the long-term.
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