Navigating a Paradigm Shift

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• On: 04/06/2023 12:49:32
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This is an excerpt from NCPERS Spring 2023 issue of PERSist, originally published March 21, 2023.

By: Bryant VanCronkhite, CFA, CPA, Allspring Global Investments

What is the biggest risk that equity investors face today?
In my view, the most underappreciated development for equity markets today is the paradigm shift that has taken place in monetary policy following the pandemic. The Federal Reserve has a dual mandate of supporting price stability and full employment. Other central banks have similar competing objectives. The fundamental challenge today is that pursuing both goals will require increasingly different policy prescriptions going forward. Something will have to give, and I think this fact is still dawning on markets.

What changed? In the decades leading up to the pandemic, inflationary pressures created by massive liquidity injections and ultra-low interest rates were offset by deflationary megatrends, such as the offshoring of production to low-cost centers. Today, some of the deflationary trends related to globalization have been reversed, and markets are now coming to terms with structurally higher prices and a growing recognition that central banks may be unwilling or unable to step in and spur growth as they had in the past. Everyone is talking about this now, but I think few have fully comprehended the end game.

So how does this shake out?
There are many zombies masquerading as viable businesses that will soon be exposed as growth inevitably slows in 2023. To see why, consider that the prescription for survival in this environment is the ability to relocate supply chains, secure scarce energy supplies, and invest in further automation and efficiency solutions that can sustain production. These are all costly investments that only companies with financial strength can make. Second, companies will need to raise prices to protect margins and sustain free cash flows, and only companies that hold a strong competitive position will have the ability to do so. The upshot is that, sooner rather than later, you will likely see a growing stratification of markets into winners and losers.

How should equity investors respond?
Active approaches will likely present a much stronger value proposition to investors going forward. Many of the factors that allowed weak companies to keep pace with better-run companies in the years leading up to the pandemic also allowed broad index-tracking strategies to flourish. Everyone won in that environment, which diminished the importance of individual stock selection. Today, that dynamic has flipped. As fundamentals take the leading role in driving return dispersion, I think investors can respond by allocating to investment strategies that actively exploit divergence in fundamentals.

As for our brand of active management, we have long discussed how balance sheet strength foretells the level of flexibility a company has to react to change—to make accretive acquisitions and capital expenditures, invest in research and development, or generate yield by returning cash to shareholders. We use our process to gain confidence in a company's competitive advantage; to ensure it has the willingness and ability to raise prices to offset increased investment needs; and to determine it is making the right investments that will allow success and separation from the pack over the next one, three, or five years. This focus has served us well in prior market cycles, and I think it will do so again in the face of the structural challenges I described.
 

Author Biography:
Bryant VanCronkhite is a managing director, co-team leader, and senior portfolio manager for the Special Global Equity team at Allspring Global Investments. Prior to this, Bryant was a senior research analyst on the team, which he joined in 2004 before the acquisition of Strong Capital Management. He began his investment industry career in 2003. He earned a bachelor's degree and a master's degree in professional accountancy from the University of Wisconsin, Whitewater.

Disclosures:
CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Material is for informational purposes only and professional, institutional or qualified investors. No retail use outside the U.S.

MATERIAL DOESN'T CONSTITUTE AN OFFER/SOLICITATION, NOT INTENDED TO BE USED IN JURISDICTION OR WITH PERSON WHERE WOULD BE UNLAWFUL.

Allspring Global Investments^TM is the trade name for the asset management companies of Allspring Global Investments Holdings, LLC, a holding company indirectly owned by certain private funds of GTCR LLC and Reverence Capital Partners, L.P. Unless otherwise stated, Allspring is the source of all data, current or as of date stated; past performance not a guarantee of future results; all investments contain risk; content for informational purposes with no representation regarding adequacy, accuracy or completeness.  Opinions/estimates aren't necessarily that of Allspring, are subject to change.  This communication doesn't contain investment advice, recommendations or research, as defined under local jurisdiction regulation.

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