Top Risks and Opportunities Beyond the Headlines

Beyond the Headlines: Accelerated Risk and Opportunities for Investors

 

Victoria Higley, Institutional Equity Portfolio Manager, MFS

How do you factor AI and emerging technology into company-level assessments?

So, obviously there's lots of current debate around generative AI, but our technology teams, and actually our experts across a number of sectors, have been debating the shifts in technology and the impact on companies for a very long time.

But with particular emphasis around generative AI, I would say there are more questions than answers right now. We have been talking to emerging companies in this field as well as well-established big technology companies. And I think our early thoughts are there's likely to be huge benefits around productivity. In a survey actually of key chief executives, around 56% said that was their main focus.

I think there are some benefits in terms of revenue drivers, about a third of that survey noted that. But actually, there's much less in terms of direct investment as yet in R&D. So, I think this is yet to come in terms of that full scale.

But the productivity gains are exciting, and I think they are across a large number of sectors. So that is something to look forward to. I think the market has been quick to discount the obvious winners, so those providing the hardware or the compute power, those in providing cloud services.

But we're having a lot of discussion around the power of data. Because those are the two key elements actually, is the quality data set and then the architecture. So it might be that some of the most well-invested companies will do particularly well if they have already invested in those. And we're exploring a lot more about proprietary data and how actually that's going to benefit a lot of companies and using AI around that.

What are your thoughts on traditional ‘value’ styles and factors?

And I think that really came to the fore last year in 2022 particularly. I think from reflection, we've just had a decade of very low interest rates, low volatility that has really favored growthier styles of managers and unfortunately, we've seen a lot of value managers leave the market. So, it's just not been as much of a focus. The unfortunate events around Ukraine and the energy crisis, but of course the massive move that we've seen in interest rates and potential for higher interest rates for longer and higher inflation, I think have made investors really rethink that sort of traditional value bucket.

And I think we are probably likely to have now the next decade of higher interest rates, higher inflation, and possibly more volatility around that. So, I think that does mean that investors need to cast their net a bit more broadly.

Henning Gloystein – Director, Energy, Climate & Resources, Eurasia Group

What risks or opportunities are the markets underappreciating?

If things go well, a major opportunity would be in Europe's industrial development over the next couple of years. We've seen Europe's industry go from emergency management, having to cope without Russian fossil fuels, and now you're seeing industrial policy being enacted to take those emergency measures and put them into a long-term adaptation process, which will support decarbonization and will probably, if managed well, bring energy costs for Europe's industry under control again and maybe even make it quite competitive by the middle of this decade. So, you can maybe, if things go well, talk of a green dividend.

Now a risk related to this, of course, is if this is badly managed, these are huge subsidies that are being spent that you create subsidized asset class bubbles, and sort of badly spent money, and then things could fail. But so far, Europe seems quite on a good track on achieving its goals for maintaining its industrial base and a sustainability drive over the next couple of years.

Lucy Eve, Senior Strategist – Global Macro-Geoeconomics, Eurasia Group

What geopolitical issues should investors pay attention to?

So, at the moment, clearly there's a lot of noise around US-China relations, whether that's the Chinese spy balloon saga, when it comes to the recent diplomatic efforts that we've seen. But also, if we're thinking about Biden's dictator comments, for example, and the way that he described President Xi Jinping.

So, I think that's one area where there's a lot of noise and we really should be paying attention to it because the US-China relationship is the relation between the two key economic superpowers of the world at the moment. So clearly big impacts in terms of how that can impact markets and the global economic outlook in terms of how that relationship develops.

So, we see that playing out in a few key ways. One potential impact of it is on near-term market volatility. So, our base case at Eurasia Group for US-China relations is a steady decline in ties, but we do also see a significant risk of a rapid and precipitous deterioration.

So that can play out in terms of near-term market volatility. There's particularly high risks around the tech sector and any areas that either side see as key for national security. So that's aerospace and defense, for example. And there's also a risk that the definition of national security continues to expand.

So near-term volatility, risks around the tech sector in particular, but I think also important implications when it comes to long-term economic growth. At the moment, we're seeing an accelerated push towards de-risking in the US and we're seeing Europe start to come up with more of a plan for its de-risking efforts. The shape and the pace of that shift in economic fragmentation and the pace of that de-risking is clearly going to have really important implications when it comes to growth.

Owen Murfin, Institutional Fixed Income Portfolio Manager, MFS

Where do you think inflation goes from here?

Well, the media and clients tend to focus a lot on spot inflation, whereas we're actually more concerned about where inflation is going to be in the future. So, if we look at the markets, certainly in terms of term inflation, it has been coming down pretty consistently and that's very encouraging.

So, for instance, the 10-year expected inflation on average analyzing the US is going to be about 2.2%. That's higher than recent history, particularly pre-COVID. But I think that's reasonable because we are expecting a spirit of deglobalization, which could be quite inflationary. And also, some of the green investments we're going to see could be quite stimulatory.

So, I think it's reasonable to think inflation could be higher, but certainly the markets don't be concerned that it's unanchored and that's what the markets are telling you about. Now the other point then is, why is spot inflation, though, so high and why is core inflation just at these sort of elevated levels, which is causing concern?

Now there's a lot of factors at play here. I think predominantly monetary policy happens with a lag. We haven't been raising rates for that long. It has been intense how quickly they've been raised, but it's been generally less than 18 months since the US and the ECB started, and it's going to come through probably more in the next 18 months.

Also, things like housing is not going to be as impacted because fewer people have mortgages relative to recent history and a lot of them are on fixed rates. And also, the economy has moved more towards services away from goods, and that's been very stimulatory generally.

And also, labor markets have just been very tight and a lot of companies are reluctant to let go of people, so there's a certain hoarding of employees for the fear of not being able to hire them back.

So, all of these things have meant that inflation hasn't come down as fast as expected, but we think with monetary conditions as restrictive as they are, the path is really for it to go down fairly rapidly from here.

What are the most attractive asset classes currently?

So, we are more concerned about recession, I'd say, than the market is. So, we're looking for an environment where risk-free yields or government yields are quite well-supported, but at the same time, credit spreads will continue to be under some sort of pressure here, particularly in the next 18 months.

So, the obvious thing to own is duration, and so we think government bonds are important part of a bond portfolio at the moment, but also those sectors which are priced appropriately for recession. So, we'd probably give two examples there. European investment grade at around 160 basis points of abundance is pretty attractive, and parts of the EM market, like local currency EM, also seem well priced for a more difficult environment going forward.

What we'd be avoiding is more cyclical sectors in the credit markets, but in particular high yield as well. There we feel implied default rates are still way too low. There's a large amount of refinancing to come in the next 18 months, and that could be challenging. So, we'd stay up in quality with a preference for investment grade over high yield.

 

 

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