Equity markets have been grappling with high inflation, rising rates and slowing growth for months. Bill Booth, Co-Chief Investment Officer at Epoch Investment Partners, tells Greg Bonnell that markets may be experiencing a regime shift, in which higher inflation and slower growth become the new normal.
Originally published on September 23, 2022
- The market is on the back foot after the US Federal Reserve delivered another super-sized rate hike and a pledge to continue raising rates to fight inflation. Joining us now for more, Bill Booth, co-Chief Investment officer at Epoch Investment Partners. Bill, welcome to the program. Can't wait to pick your brain about all this.
- Great to be here, Greg, Thank you.
- So let's jump right in. Obviously, yesterday afternoon was an interesting one. I mean, we got the 75 basis points that we were expecting. We got the tough talk that recently, we've become accustomed to from Jerome Powell. The market reaction was a bit interesting, ultimately to the downside. But walk me through, what were you seeing out there?
- I think we should start calling Fed Day "No Fun Day" for investors anyway. It's-- the volatility around these announcements has been quite remarkable. And as you pointed out, the market action was pretty interesting in terms of initially declining then rebounding during the press conference and then selling off into the close. And I think it's now abundantly clear, the Fed's sole mission in life, at least at this stage in its life, is to kill inflation. And the message was pretty much, they'll do whatever it takes to get inflation back towards its longer term targets.
I think, you know, investors are grappling with this reality that the Fed is willing to sacrifice the economy to some extent, willing to sacrifice the labor markets. And Powell basically said, if we're going to make a mistake, it's basically going to be keeping rates too high for too long and not making the mistake of pivoting early. And so I think that's really what's starting to settle in here, as we now sort of have a higher-for-longer-type situation.
- He really seemed to pour cold water. I mean, not only-- we go back to Jackson Hole, and the pivot, boom, just throw that right out of the door. He wasn't in the mood to give us any hints about that.
Now there's really cold water in the idea that, I guess the last refuge for investors was thinking, OK, they've got to get aggressive. They've got to get inflation under control. But once they get there, it's not going to take too long before they start cutting again. But they seem to really want to throw that one out the door, as well.
- Yes, I think, you know, they are really concerned about inflation expectations becoming embedded into the psyche of the American consumer. And so it's clear inflation is top of mind. And I don't think, you know, they're going to stop anytime soon. In fact, I think the big surprise yesterday was that the terminal rate is now sitting somewhere around 4.6% in 2023.
And so, you mentioned at the top, that tech is really feeling some of the brunt of this. Make sense, because the first impact of rising interest rates of course, is on valuation multiples. And some of these high flying tech stocks have enjoyed very lofty multiples, really during this last decade of quantitative easing. And as the regime is now shifting, they're bearing the brunt, at least, of the valuation compression that we're seeing in the market.
- Well, let's talk Bill, a little bit about that, a regime shift that was on the Epoch website the other day. I was checking out one of the White Papers, I think that your shop published in the summer. And we had grown accustomed to a certain regime for the past decade. And if I was reading the White Paper correctly, it was basically saying, yeah, that's over now.
The decade that is behind us is behind us. We are entering a new kind of decade. What does that look like for investors?
- I think first and foremost, it's just higher levels of inflation. And so certainly, we've gone through a decade of modest inflation, fairly decent economic growth. And I think as we look to the longer term, inflation will probably be higher than we've become accustomed to. I'm not saying it's going to be 5, 6%. But maybe 3% is the new 2%, if you will.
And then certainly from an economic growth perspective, there's lots of issues that are weighing on potential growth in economies around the world. Certainly, demographics, we have an aging population that will naturally slow growth in the wake of all of the supply chain issues associated with COVID. And then the Russia-Ukraine situation, we probably are starting a new era of deglobalization.
And the benefit of the deglobalization is maybe these supply chains become more reliable. But certainly, they're going to become more costly. And so I think as we look forward, growth is probably going to be lower than we've experienced over the last decade. Inflation is probably going to be higher.
- For investors in that climate, seeking return, looking for yield, where do they start to look now? What-- what do they have to say about their mindset? Because as you said, there was a period there where like, you know, if you were rolling with the tech stocks, then good for you. If you made a lot of money in that space, you were just getting it at a share appreciation and the big run up. Where do we look for our returns going forward?
- I think if you look at the last decade, what's interesting is when you look at the components of equity returns, you sort of have valuation multiples go up and down. You have earnings growth. And you have dividends.
And what's been interesting is valuation expansion has been a big driver of these outsized market returns over the last decade. And now, I think you have to go back to those other two components of earnings growth and dividends really, to generate the bulk of your returns in the equity markets going forward. So for us, that would basically mean look for those companies that are selling products and services into structurally growing end markets, companies that are exposed to long runways of growth, and companies that are profitable.
I know a lot of the unprofitable tech or the so-called Story Stocks were investor favorites over the last several years. I think that game is largely over. And at the end of the day, when you're buying a stock, you're actually buying a business. I think sometimes people forget that.
They see a ticker and a price. And they don't realize that there's actually a real business underlying that stock in the price. And I think you need to focus on companies that are profitable, cash-generating, and really have strong balance sheets. Because I think the other feature of maybe this new era or this new regime is probably heightened volatility and uncertainty.
The world order seems to be falling apart a bit. We have geopolitical issues left and right. We have this energy crisis with Europe at the center of it. So I think just the range of outcomes going forward is probably also wider than what we may be accustomed to over the last decade.
- Two qualities that I have been shocked in myself, because at this age, I should have this under control. But it seems like in the new paradigm going forward, we're going to need to be patient. And we're going to need to try to take some emotion out of it. And I've been surprised by myself lately about my lack of patience and my excessive emotion. I'm assuming that in the path that we're laying out going forward, we're going to have to get a little more disciplined with ourselves as investors.
- I think so. And it's sort of the forest for the trees arguments because if you think of what's happened in the markets today, there are areas that have potentially very attractive long-term growth prospects. If we talk about green energy, or automation, or just technology more generally, obviously, I think technology is really fueling a new Industrial Revolution, everything from the Internet of Things to the cloud to big data.
And if you take a step back from the day-to-day volatility, you kind of think to yourself and say, well, has any of that really changed? In 10 years from now, are we going to have more semiconductors or less? Are we going to have more automation or less?
And if you can, to your point, be patient, some people may view the sell-off in some names as being an opportunity. One of the arguments I had heard through the better part of the bull market is everything so expensive. And I missed this stock, and I missed that stock. And in some cases, perhaps, investors are getting a second bite at the apple, understanding that there may be more pain to come in the short term. But if you do the fundamental research and analysis and have conviction in some of these companies and the end markets that they're selling into, it's a time that you could actually quite get excited when lots of people are being fearful.