2022 has provided numerous challenges, as global markets have faced rising inflation and interest rates, supply chain bottlenecks and Russia’s invasion of Ukraine. The result is a cocktail of negative sentiment, illustrated by the S&P 500 having one of its weakest years ever in US dollar terms, only topped by the Great Depression and the 2008 financial crisis. Bonds have performed even worse, with 2022 being the greatest yearly fall for US 10-Year Treasuries since records began. Never have both equities and bonds correlated so closely, showing little room for hiding in a tough market environment.
However, it is important to look at the wider context in times of short-term volatility, and as long-term investors we view it as a rare opportunity to buy great companies at great prices. Our analysis of the World Stars portfolio shows a 2023 estimated P/E of 22.5x, close to its lowest level since the inception of the strategy back in 2012. This is mirrored by the MSCI World trailing P/E of 17.2x, 19% below its 25-year average of 21.1x. Despite this, many of our stocks continued to report positive earnings growth and excellent cost control in Q3 2022, painting a rather different picture of the economic environment. Combined with valuations at highly attractive levels, this presents a rare opportunity to invest in high quality companies.
The question on everyone’s mind is when the global equity market will start to sense the peak in inflation and hence the peak in rates; and start to look ‘over the top’ of the interest rate curve. The market is of course forward looking, but the extent of its forward vision varies according to the circumstances. In times of volatility/global uncertainty/turbulence the horizon comes back in, and myopia is more prominent. In calmer times the horizon moves out, confidence rises, and more value is placed on earnings and cash flow forecasts further out. This change in paradigm can affect quite sharp changes in mood/market interest. We feel that the peak of inflation and rates is now and that businesses with strong fundamentals and strong cashflow will begin to rerate.
Latest US CPI data suggests this is already happening, with 7.7% now its lowest point since January. This follows several other indicators that inflation has peaked, including encouraging PPI data out of China, showing signs that supply chain bottlenecks are beginning to ease. Now is the time for investors to look forward rather than back and take advantage of this rare opportunity.