One of the topical subjects in the investment industry is the inflationary outlook. Inflation is an important factor because it determines the discount rate on investment asset classes, with higher inflationary expectations leading to higher return expectations that then result in lower asset values. On the surface, the headlines of the most recent Federal Reserve survey of policymakers, known as the “Dot Plot,” would suggest two interest rate increases by 2023, one year earlier than the prior outlook of 2024.
While this headline may appear “inflationary,” it is important to dissect the underlying commentary and nuance surrounding this, in order to assess whether there has been an authentic shift in Federal Reserve policy. Indeed, Federal Reserve Chair Jerome Powell stated that this Dot Plot be taken “with a big grain of salt” and even suggested in his longer term outlook that there is the “possibility inflation could be quite low going forward” and that “we do expect inflation to move down.” Further, these comments comport with our views of a lower for longer interest rate environment and the beginning stages of a slow growth and low inflation investment cycle that tends to portend well for growth investing.
Chair Powell even welcomed the modestly higher growth outlook, stating that he believes stronger wage growth is “natural in a strong economy” and that most of these higher wages have been “for market entrants in low skilled jobs.” He also added that it is “not wise to be wed to a particular measure on inflation,” that he doesn’t “expect higher prices to feed into expectations” and that the “labor supply-demand crunch will clear.” On the transitory nature of inflation, Chair Powell noted that the “high inflation readings we are seeing are starting to abate” and cited the example of the “lumber retreat” showing that inflation is transitory. Therefore, the commentary remains largely consistent with prior reports, with the fixed income markets affirming this through continued bullish flattening of the treasury yield curve, indicating that market participants had overestimated their prior inflationary expectations.
In the longer term, we would like to distinguish for clients the difference between buying a stock and buying a company.
As long term investors, we buy companies. This is because we believe that the companies we select have unique business qualities that will lead to durable earnings growth, which will ultimately be reflected in valuations and recognized by investors. Oftentimes, these businesses are buoyed by secular growth characteristics, in which they are targeting large and growing addressable markets undergoing meaningful shifts in industry behavior. Many investors, however, pride themselves on buying stocks.
Investors who buy stocks tend to have a shorter time horizon and may be influenced by a more crowd-driven approach, with a key example being the Reddit “meme-stock” investors. This phenomenon exists when there is a heavily shorted company that then attracts a widespread following on Reddit, amplified by colourful commentary, resulting in a large volume of retail purchases that often have little to do with the underlying intrinsic qualities of the business.
As investors, we believe the price of a stock does not necessarily reflect its value, which is why we perform detailed research and due diligence on every company within our portfolio. We believe this method of investing allows durable value to truly be surfaced, has greater longevity, and is less influenced by market sentiment that often creates amplified volatility.
From a portfolio construction perspective, the S&P500 has oscillated between growth and value styles of investing. Our portfolio also reflects a mix of these characteristics, with consumer, real estate and banking companies on one side of the economic ledger and secular growth industries with long-lived characteristics on the other side. We believe this balanced approach to portfolio management enables us to participate in the early cycle re-opening of some of these companies while at the same time retaining a long-term growth focus.
We welcome your feedback and hope you are enjoying the start of summer.
Grace, Sam, Leslie and Jennifer