Page 11 - ISQ Outlook 2023

INVESTMENT STRATEGY QUARTERLY JANUARY 2023

“ We have moved from bond and stock markets driven by liquidity to

markets that are now driven by fundamentals—ultimately a better,

more stable model for growth and wealth creation. ”

The two primary inputs of the economy, labour and capital, have by liquidity to markets that are now driven by fundamentals—
been transformed. Near-term economic challenges are plentiful, ultimately a better, more stable model for growth and wealth
but the backdrop for better long-term outcomes may be creation.
improving dramatically. There is growing evidence that compa-
nies are adapting to these challenges. A significant uptrend in For fixed-income investors, the worst is over. Historic mark-to-
capital expenditures along with an enduring, positive trend of market losses on individual bonds should slowly recover as
investment in intellectual property products bodes well for pro- upward pressure on long-term rates slows and reinvestment
ductivity gains going forward. begins to capture higher yield levels. It is noteworthy that bond
prices have been largely driven by interest rates and liquidity, not
Digital expenditures (robotics and the like) have grown by double credit events. The U.K. pension sector dodged a bullet in this
digits over the past year. Companies embracing and optimising respect over the autumn as economic orthodoxy returned after a
the realities of the hybrid work model can gain a competitive distinct wobble. Liquidity issues (due to continual selling from
advantage in a tight labour market. passive vehicles) are more pronounced in the U.S. municipal
market, which resulted in long-term municipal yield ratios cap-
The era of financial engineering is over. The successful businesses
in this new regime will be those with efficiency in the deployment turing 85% of the yield of U.S. Treasuries versus 65% at year end
of labour and capital. The reset of the bond and equity markets 2021. This higher ratio made municipals more attractive, and
sets the stage for capital allocations based on fundamentals, not combined with generally falling yields, they posted their best
speculation. The destruction of trillions in capital in instruments monthly performance in November since 1986.
like crypto exchanges and non-fungible tokens (NFTs) marks an The economy and capital markets may recede for a period, but the
important inflection point in the capital allocation process based resilience and ‘reordering’ of the economy sets the foundation for
on easy money. a more productive economy and capital markets in better bal-
The financial press may come to remember 2022 capital market ance.
returns as an epitaph for balanced investing. During such regime
shifts, correlations across asset classes are high. In the U.S., by
way of far from exclusive example, a portfolio consisting of the
S&P 500 and the 10-year U.S. Treasury note suffered losses of
around 15%; however, a portfolio consisting of intermediate
investment-grade bonds and quality dividend stocks was down
less than 10%. More importantly, the ‘income’ component of the
income investing landscape has markedly improved with yields
on bonds at decade highs and dividend style factors outper-
forming. Dividend growth—growth at reasonable prices—will
continue to outperform the broader equity markets. Balance
sheet quality, management, capital deployment, and labour pol-
icies will be factors underpinning performance in the post-COVID
economy. We have moved from bond and stock markets driven

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