Global stocks as measured by the MSCI ACWI rose by 7.2%1 for the first quarter of 2023. The year started with whipsaw movement as a strong January rally was reversed in February. This was followed by a challenging March highlighted by a scare across the financials sector that began with the failure of Silicon Valley Bank Financial Group.
Hotter than expected inflation data and continued tightness in the labor markets continued to push rates higher, despite signs that the year-plus rising rate environment has started to form cracks across economies.
Outlook and Challenges
The impact of rising rates on real economies typically follows a 12-month lag – these impacts have begun to be felt, and our base case forecasts a higher frequency of negative earnings revisions for 2023. Companies with stronger fundamentals and higher-quality attributes such as low debt levels and higher returns typically perform best during such periods.
Our approach favors companies with higher quality and growth attributes, though we’ve recently emphasized more on quality at the expense of growth as we prepare for the economic impacts of rate increases to unfold over the coming months. As economic growth becomes scarcer, we believe portfolio companies with structural tailwinds will return to favor.
Opportunities and Fund Strategy
Our focus as thematic investors is on finding private sector solutions to some of the world’s largest and most persistent challenges. Broad shifts in the global economy take years to run their course, and global challenges such as climate mitigation, access to healthcare and infrastructure needs are not solved overnight.
Importantly, companies providing solutions to these massive challenges should experience more resilient demand for their products and services than those that are reliant upon cyclical demand, in our view. We expect this to translate into more resilient earnings, which may hold increasing appeal going forward.
One such persistent challenge is the labor shortage facing the healthcare industry (i.e., nurses and doctors), which pressures the capacity for hospitals to treat patients. We own several medical device companies in our portfolios that provide solutions to improve nurse and doctor productivity, as well as enable patients to be treated in less acute care settings such as the home, all while improving patient care and outcomes.
Furthermore, new diagnostic tests and instruments help automate manual work in laboratories and speed up medical decisions. For instance, self-administered drug delivery services (such as a medicine pump patch a patient can wear at home for a medicine that must be infused) from West Pharmaceuticals, or an eye measurement device from Alcon (an optical biometer) that can help reduce pre-operative patient measurement times.
Another area of need is to increase the productivity of global societies to facilitate economic growth. Artificial intelligence (AI) holds significant promise in this regard, via the automation of low-skill tasks, working alongside humans to write software code, design new drugs and view medical images for signs of disease.
The adoption of new large-language AI models such as ChatGPT is increasing the demand for computing power and opening up new business models. Advanced Micro Devices (AMD) is providing both central and graphics processing unit (CPU and GPU) solutions to allow its customers to train and run AI models in an energy-efficient manner. Taiwan Semiconductor Manufacturing Company (TSMC) will benefit from the growth in computing usage overall and from the increase in average selling price of its wafers. And Microsoft is incorporating these new AI models to make its core search and software portfolio more effective for its users.
We’re balancing having exposure to select higher growth companies with an increasing exposure to durable and more protected business models. In this cohort, we recently added names such as Procter & Gamble, Unilever, and Haleon, whose durable franchises should offer resilient results amidst a macro-economic slowdown. We exited cyclically exposed names like Trex and Owens Corning and names where there were growth concerns including Nike and Apple.
