(IE - Investment Executive) - Volatility is likely to continue through 2022, but that is no cause for panic, says Kent Chan, equity investment director for Capital Group’s Global Equity Fund.
In a discussion about the stock market’s turbulent start to the year on the Soundbites podcast, Chan said volatility tends to reveal investment bargains.
“Where can we find opportunities? That’s really what we’re focused on now,” he said. “Which companies have possibly been mispriced? Which companies still have pricing power and can hold up in potentially longer inflationary periods? Which are going to be able to handle higher costs of debt and potentially slower global economic growth while still generating free cash flow?”
After January’s tech sell-off, he is looking for deals in the digital space, where more and more consumer commodities are becoming ‘smart’ products with internet connectability and artificial intelligence.
“Our cars are becoming smart. Our refrigerators and washers are becoming smart.”
Because of that, Chan said, semiconductors and chips are “what’s really driving the digital economy.”
He also believes there are promising opportunities in the health sector, supply chain infrastructure, and heavy-equipment manufacturing — particularly for the mining industry where there has been “significant underinvestment” in recent years.
Overall, however, as world economies continue to intertwine, he is less interested in regions or sectors than in company fundamentals.
“While 11 sectors lost ground last year, there were still some stars within that,” he said. “And where we used to be able to think about investing on a regional or local basis, that world is gone. It’s going to be the best companies in the world, and you want to get in front of, get invested in, and also hold onto those best companies.”
Chan said nothing beats careful analysis when considering where to put investment dollars.
“If I do a sensitivity model of what a good, bad and truly ugly case might look like over the next five to 10 years, I can get a pretty good read on which companies will be relatively better positioned than others, even in a bad environment. That’s what fundamental analysis will do for you.”
He is not expecting a smooth ride in 2022, though. There are too many variables, from Covid exits, to inflation, to geo-political risks, to supply chain contortions.
“All the uncertainties point to continued volatility in markets,” he said.
Chan said that while some investors might have felt spoiled by the exceptional performance of equities over the past couple of years, portfolio managers were feeling increasingly stressed, knowing the high-flying performance couldn’t continue forever.
“Eventually there is going to be statistical mean reversion. And Mr. Market can be pretty tough when the economy decides to mean-revert,” he said. “The lack of volatility is unusual and should not be expected to persist. Nothing goes up in a straight line. But, also, nothing goes down in straight line.”
He described market volatility as a natural and even healthy part of investing.
“You want volatility to create opportunities. Volatility is part of a rising share price. A sharp rise in share prices creates opportunities to make profits or take a gain. If you’re prepared with the fundamental analysis, and you know which companies will be able to handle the volatility, then you know which companies you’d want to invest in on the way down.”
Similarly, inflation may be scary to some investors, but he says it serves a purpose. For one thing, it proves that the economy is not “broken.”
“The fact that we’ve printed a lot of money in the United States and the developed West, if there wasn’t inflation that should worry you,” he said. “Because, if not for that, you’d have a much bigger problem on your hands.”
He pointed to Japan’s experience over the past 30 years. Despite successive phases of capital spending, indebtedness, property bubbles, and stock bubbles, all countered by printing “a lot of yen,” there’s still little hint of inflation.
“We should thank our lucky stars for inflation because, to us, that proves that the system isn’t broken,” he said.
Another positive side to inflation is the chance for companies to realign pricing that has been essentially frozen for the past decade or so.
“To the extent that now inflation is going to put pressure on companies to either improve or become more efficient in their manufacturing, if possible, companies can also raise prices,” he said.
By Kent Chan
February 22, 2022
