TThere is a lot of uncertainty in the market right now as concerns about interest rates, economic growth and inflation weigh heavily on the minds of investors. Uncertainty and volatility are environments in which active management typically outperforms, and T. Rowe Price has described current market climates as well as potential avenues to follow from there.
David Eiswert, CFA and portfolio manager at T. Rowe Price, recently wrote a white paper on the stock market cycle and the current state of the markets according to the company. Due to the economic shutdown, the strengthening of the Fed has led to an environment with little systematic risk, both now and potentially in the future if interest rates remain low and the pandemic continues to improve.
Right now, interest rates are low, asset prices are high, and there is no credit cycle to pressure and disrupt things. This has given rise to what Eiswert calls “negligent risk-taking in financial markets,” and he argues that this type of behavior is best approached through active management.
While there is general inflation in the labor market, there is always the question of whether it will become a permanent feature or whether it will increase. “While a certain degree of labor inflation is a good thing, an escalation would likely require a change in monetary policy that could potentially disrupt the cycle,” Eiswert said. The resumption of schools in the fall could play a mitigating role in the balance between labor supply and demand.
In addition to general labor market inflation, there are pockets of “absurd” inflation such as lumber, DRAM and used cars. This is a scenario where everyone loses because all assets fall; this is something that happened on a small scale in December 2018, explains Eiswert.
Added to this are the current interest rates, which are historically low. “We are wary of the level of interest rates today and believe that the price of treasury bills represents more of a hedge and aversion to risk than a precise indicator of the future economy,” Eiswert said. Although Eiswert believes interest rates should be higher, they should be kept within reasonable limits so as not to cause serious problems.
Active management can help thread the needle
With the pandemic, many growth stocks have enjoyed unprecedented gains that have not lost momentum even as economic reopening has become increasingly possible.
“Mega-capitalizing tech stocks have dethroned consumer staples and utilities as a source of defensive market positioning. We are seeing significant congestion and momentum in some of these growth areas, especially in PSPCs, IPOs, and MEMEs.2 actions, ”Eiswert explained.
This is a situation that Eiswert considers “dangerous” and where the benefits of active management can really shine by ensuring that only properly valued assets are invested. there is lower inflation than today, coupled with higher rates but which still maintain a status quo while remaining historically low.
This scenario could be created by the slowdown in the Chinese economy, the acceleration of COVID-19 cases from Delta (which would help slow the economic recovery) and the continued improvement in supply chain functionality. In this scenario, “absurd” inflation disappears and the growth of the economy stabilizes, creating an environment in which stock pickers thrive.
“Our goal is to hold stocks where we have a sense of improving economic returns while avoiding stocks that involve unnecessary risk and should be avoided. This is our role as bottom-up fundamental stock pickers, ”said Eiswert.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.