Focus on quality for success in equities
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Focus on quality for success in equities

Investors should not expect everything to go ‘back to normal’ in 2023, says Melda Mergen. Higher inflation and a weaker economic environment will mean not all companies will thrive.

As the economy reopened after the Covid-19 pandemic, we saw a lot of one-off drivers of inflation, but longer-lasting drivers have also been unleashed. So, we are now seeing changes in supply chains – companies reshoring and building out new networks – and geopolitics, and these don’t resolve quickly. I do expect inflation to fall, but not back to pre-pandemic levels. When a dislocation like this happens you never go back to where you started, and where we end up is one of the key questions for 2023.
Inflation generally means equity valuations come down, and we saw that through 2022, but on a broad market basis. I think that we will see greater dispersion in terms of valuation in 2023, with longer duration equity – companies with growth expectations farther out in the future – suffering more. Investors will have to be more careful about what they are willing to pay for future earnings, and demands for profitability will come sooner. All of this will mean that companies that aren’t able to deliver earnings are more likely to see the market take down their valuation.

Cash on hand will matter

Many investors think of valuation in terms of price-to-earnings (P/E) multiples, and although that metric is useful it is not the only measure of a company’s value. I think free cash flow will be more important as a metric because it will be a good indicator of how resilient a company may be in a weaker economic environment and while inflation is running higher. Cash on hand can also help deliver stock buybacks, which can support a company’s stock price. It will be a lot more expensive to fund buybacks through debt so free cashflow and dividend growth (rather than the absolute level of yield) are both metrics that may indicate a higher quality company.

Relative opportunities, resilient companies

While economic growth is slowing, at this point it doesn’t look like a recession in the US will be very deep. In contrast, economies in Europe are under significant stress and a deeper recession there seems likely. In emerging markets, we have seen economies under stress from China’s zero-Covid policies, the strong US dollar and geopolitics.
In thinking about global opportunities, at a high level the US is more attractive than other regions. I also think that small caps may offer greater opportunity than large caps, especially since larger companies tend to have greater non-US revenue exposure, with around 35% of revenue outside the US. I also still think that a tilt towards value over growth makes sense. There are certain value areas – industrials or energy, for example – that will still be benefiting in 2023. That said, growth is becoming more interesting. Many growth companies underperformed in 2022. However, we know their business models are not broken, we know they still have competitive advantage. But because interest rates rose in 2022, the valuation of these companies came down, there was a significant rerating. If you believe that is now done, then I think growth will be very interesting too.
However, either way you will need to go deeper than big picture observations to succeed in 2023, meaning an active, company-by-company approach. Passive indexes, especially in international markets, can have embedded concentrations that can hurt portfolio performance. To succeed in 2023 you will really need to distinguish between companies that are more resilient and those that aren’t.
14 December 2022
Melda Mergen
Melda Mergen
Global Head of Equity
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Focus on quality for success in equities

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For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is an advertising document. This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services.

Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. Risks are enhanced for emerging market issuers.

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In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is an advertising document. This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services.

Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. Risks are enhanced for emerging market issuers.

The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be appropriate for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either.

Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This is an advertising document. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In the USA: Investment products offered through Columbia Management Investment Distributors, Inc., member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC.

In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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