Bolton, co-chief investment officer of BlackRock Fundamental Equities, and said that when seeking out the typical companies that they invest in – with resilient business models, present-day cash flows and growing dividends – they may not be found in the usual, go-to sectors going forward; namely technology and consumer.
He said that that these aforementioned sectors “are more vulnerable in this changing economic environment, and others where we see a greater prospect of earnings strength”.
The macro events being referred to include the aftermath of the Covid-19 pandemic, in particular the supply and demand issues it created.
“This stoked demand at a time when supply chains were disrupted, creating inflation,” Bolton said, mainly in equity markets “boosting valuations”.
Consequentially, central banks have sought to drain this excess money supply by raising interest rates and reducing their purchases of government bonds.
According to Bolton, this quantitative tightening trend may have only just begun and so far created elevated volatility, which he expects to last for the rest of 2022.
This has already had a notable impact on the tech sector near term, with valuations on some stocks “plummeting this year”. But the impacts could be more long reaching and undermine some of the key themes that drove this sector in the pre-Covid years.
The investment officer said that with a sharper focus on cash generation in the wake of higher borrowing costs “this could drag down the broader sector.”
“Companies such as Uber, Robinhood and Coinbase have all announced cost-cutting measures over the past few weeks, and this might in turn reduce the amount being spent on other areas of tech such as digital marketing,” he said.
Streaming business have also begun to weaken as consumers worry about the cost of living.
“Even some of the more resilient areas in tech this year – such as enterprise software companies – are showing signs of vulnerability as some of their smaller customers limit their spending,” Bolton explained.
This last factor was a particular headwind for consumer stocks, with fast-food giant McDonald’s reporting its customers were trading down as they “feel the pain of higher prices”.
Major US chains Walmart, Costco and Target have also reported “an excess of stock because of the shift in consumer spending as well as over-ordering during the supply chain crunch.”
Bolton said: “Consumer goods companies may struggle as spending wanes or is redirected to services like travel.”
All of this has culminated in Bolton taking a more cautious view on tech and consumer and going bullish on financials, especially banks.
He said that the higher interest rates would benefit banks because they can increase their net interest income (NII).
“This means profit margins at ‘rate sensitive’ banks – where NII grows more as rates rise – may expand even if growth slows, and they could be able to buy back shares.”
The investment officer pointed out that banks were still trading on low valuations despite this sector boost. For example, European banks are trading near 2008 GFC levels.
But lingering concerns of a global recession could be the cause of market lacklustre towards banks, as Bolton explained: “One reason is that a recession would be bad for banks – they would have to set aside more money to cover loan losses.
“But we believe the higher net interest income would more than make up for this, depending on the severity of any recession.”
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