Global Equity Investor insight | June 2023

Jeremy Richardson

Hello, this is Jeremy Richardson from the RBC Global Equity Team here with another update. Now as investors we like to think there's a strong connection between company fundamentals and the recognition of value in investment portfolios. In fact, in our opinion, the single biggest driver of long-term share price performance are those company fundamentals, the profits, the dividends, the cash flows from those businesses, but the transmission of that value from those fundamentals through to the recognition and the share prices is not always smooth or linear.

You can get disruption from crosswinds coming from economic shifts in the investment landscape, and it kind of feels as though we've had that sort of tension in markets in the recent past. Yes, we have had some focus on company fundamentals, and I would highlight companies focusing on artificial intelligence in terms of the most recent results season, and in particular the market wanting to recognise businesses who have quite a demonstrable way of monetizing the potential of artificial intelligence in the short to medium term. Whereas for those who are focused more on the medium and longer term, where artificial intelligence is still somewhat conceptual, there’s still a degree of skepticism on the part of the market. However, that pocket of relative strength is also having to contend with the emergence of new sort of macroeconomic tensions in the investment landscape. And if you just think about that in terms of regions, you can see that there are some new things here to deal with.

So, let's go to the US first, where obviously we've had the whole conversation around the debt ceiling. And as investors we all hope that there will be a satisfactory resolution, nobody wants to see the US default. But as investors we also have to recognise that any agreement is likely to involve a compromise. And that compromise may come at a cost because we did quite like, as investors, the way, and I’m speaking generally here, the way in which things like the Investment Inflation Reduction Act or the CHIPS Act was beginning to direct levels of investment towards particular industries which was reshaping those industries probably in a very positive way. And if, as a result of any debt ceiling compromise, any of that investment gets trimmed or cut back, that may feed through into expectations for those industries and the companies within that.

And if we come now to Europe, some signs of weakening economic momentum, particularly Central Europe and Germany, driven by lower levels of exports and some signs too that inflation is proving harder and longer to squeeze out of the system, particularly again in Central Europe and in the UK.

If we move towards China now, we spoke about this last time where we noted that there were some early signs from companies reporting that maybe the economic recovery post-pandemic was proving a little bit weaker than investors had been expecting. I think that's been confirmed by subsequent company reporting. Plus, we've got some new stories that maybe there's a wave of COVID beginning to emerge in China, which also poses a risk of additional disruption. If I tried to sort of pull those sort of three things together, it kind of feels as though the market generally is having to contend with this sort of a slower pace of adjustment from that post-pandemic world. You know we have been dealing with disrupted supply chains, higher levels of inflation and that feeding through into higher levels of interest rates needed to tame that inflation as we headed towards, hopefully, lower inflation and a world of lower interest rates.

For investors, that kind of new normal is very much to be welcomed because that nice sort of stable macroeconomic consensus with low inflation and lower interest rates, but probably a much more conducive environment for that value creation, you know, the recognition of that transmission of value from company fundamentals through to share prices for that value creation to be recognised. So, this sort of this sort of disruption that we're seeing, this sort of tension between the macroeconomic situation is improving somewhat unhelpful.

Now, it was never necessarily the case that that adjustment from post-pandemic towards a new normal was going to be smooth and linear. But I think there was perhaps a hope that we would have gone further already on the path towards low inflation than we might have done already. That's not to say that inflation is necessarily going to pick up from here. I think generally the market is believing that we've probably seen the peak, but it does appear to be the case that central bankers are finding that the path to lower inflation is taking longer than they would like, and that does tend to mean that we may continue to see further interest rate increases just to make sure that the job on curbing inflation is finally done for good.

And for investors, that's a bit of a headwind still because higher interest rates do negatively impact valuations and does create some degree of uncertainty in the market. So, we're going to have to be a little bit patient, I think, before we can actually get towards that sort of macroeconomic consensus where that value transmission from fundamentals through to share prices happens in a much smoother and orderly fashion.

But if we take a step back and try to think about the bigger picture, the journey that we're all on here, then I kind of feel as though that the direction of travel still remains the same, because when we think about those adjustments to interest rates that the market is expecting, or which have been communicated by central bankers, the changes the increments are much, much smaller than they used to be. So it does feel as though we are getting close to a point whereby the central bankers, the policymakers, are going to express themselves as being comfortable with the level, with the trajectory. And when that happens, then that valuation headwind from higher rates should abate, and that should lower the amount of uncertainty in the market and hopefully mean that that value transmission from great businesses with wonderful fundamentals through to share price performance can happen in a much smoother way.

I hope that's been of interest and I look forward to catching up with you again soon.