TheChek News Flow

Maisonneuve: There are several implications for equity investors of the low rate, low growth environment that we expect over the secular horizon. The combination of high leverage in the global economy (mostly due to elevated government debt, which is in turn due to actions undertaken during the crisis to ease systemic risk) and slack in the global economy (as shown by relatively elevated output gaps) is constraining the ability of central banks to normalize monetary policy quickly – therefore it is likely to come at a very measured pace. In other words, the patient is healing, but that doesn’t mean he can be taken off life support overnight! In addition, the combination of this environment together with key long-term trends that affect global supply and demand – namely the need to adjust to competitiveness in a lower-carbon economy, important demographic shifts globally and continued shifts in emerging markets – supports the case for lower long-term economic growth globally.

Overall, however, the low rate environment will be supportive for stocks provided inflation remains subdued, as companies can take advantage of historically cheap financing. While bank lending remains constrained, particularly in Europe, good companies – such as Apple recently – are good examples of how companies are using low rates to tap the market for liquidity. This access to financing is particularly helpful to companies in sectors or activities with attractive demand profiles relative to overall demand in an otherwise slow growth world. This outlook means that investors should look for alpha and stock-picking skills as opposed to equity beta in the years to come. Strong teams with strong processes and proven ability to exploit market inefficiencies are key.

Also, current valuations are fair. Globally, they are not cheap, but neither are they expensive. And, in a world headed toward low real policy rates, equity risk premiums are exhibiting unusual characteristics relative to historical levels. I believe that in a relatively stable environment, equity markets exhibit attractive expected-returns-to-valuations ratios, especially when considered versus other sources of investment returns, such as cash. In emerging markets (EM), valuations are in fact inexpensive, but there are other issues in EM, including the difficulties in Russia and the steep slowdown in growth in China. Those pressures are mostly priced in, however, and underweight investors should consider adding to their positions. While emerging markets have been hurt by the prospects of tapering and policy normalization in the U.S., the “New Neutral” outlook may help reverse some of those fears. The extent to which EM countries can use interest rates to manage their economies and limit upward pressure on their currencies will likely be the key differentiator in secular EM performance.

Volatility is another important consideration, and here, one must understand the relationship between a stable economic environment (low growth, low inflation, low rates) and equity markets volatility. While volatility as measured by the VIX index has come down sharply recently, we should expect bouts of volatility surges that coincide with unexpected pressures, political or otherwise, that might appear in a world with a delicate economic and geopolitical balance.