While markets have recouped some of the losses of the first half of 2002, veteran investor Hilda Applbaum warns that they may be downplaying inflationary pressures that must still be dealt with by central banks.
With the potential volatility ahead, Applbaum, the lead manager of the $1.8 billion silver-rated 4-star Capital Group Global Balanced Canada F, urges investors to stay the course and focus on longer-term results, rather than dwell on short-term market gyrations.
“I do believe that off the lows of June there were some values to be had,” says Applbaum, a San Francisco-based portfolio manager with Capital Group Companies, who joined the firm in 1995, after serving as a principal investment officer and director of research at the California Public Employees Retirement System, and earning a master’s degree in economics from New York University in 1987, “Things had over-corrected, though not across the board. But it was a set of circumstances where price declines had probably gotten overdone.”
Market’s a Bit Too Bullish on the Rebound
“In July things were somewhat over-exuberant and market participants were overly concerned about missing the bottom,” says Applbaum, “In addition to finding value, and making investments where there were opportunities, I think that it’s become a momentum-driven market. We had gone a bit too far, too fast.”
Applbaum argues that the Federal Reserve has to continue to raise interest rates because it has yet to tame inflation. “Some of the inflationary pressures have diminished. But in the last few days, we have seen unexpectedly high inflation in places like the U.K. The central bank of New Zealand has more aggressively raised rates in light of the inflationary pressures they were seeing,” says Applbaum, “And certainly for Europe, unless we have some quick remediation of the Russia-Ukraine conflict, they are likely to experience continued inflationary pressures as they encounter high energy prices as they go into winter.”
Interest Rates Still Need to Go Higher
Emphasizing that it is a personal view, Applbaum maintains that the recent equity rebound has come too fast, and too far, and central banks must avoid the mistake of not raising interest rates far enough: “We don’t like rebounds in COVID and we don’t like rebounds in inflation. It’s important for central banks to put the kibosh on inflation. They know how to get economies out of recessions. Stagflations pose a much more complicated scenario for them. It’s more important to deal with that, and risk a mild recession,” says Applbaum, adding that she is optimistic that central banks will, absent political pressures, take the right course of action.
Year-to-date (as of Sept. 1) Capital Group Global Balanced Canada F has returned -12.29%, marginally lagging the Global Neutral Balanced category which returned -12.05%. On a longer-term basis, however, the fund has outperformed the category as it returned an annualized 3.11% over the past three years and 5.14% over five years. In contrast, the category returned an annualized 1.93% and 3.25% for the corresponding periods.
Bad News is Mostly Priced In – But There is the Unknown
While it may appear that markets have priced in all the bad news—such as slowing economies, the end of monetary stimulus and the Russia-Ukraine war---Applbaum cautions that there may be more to come. “Markets do a good job of baking in about two-thirds of something. On the actual news, there is probably a bit more that the market has not anticipated. If you take U.S. interest rates and the forward yield curve they are anticipating it will go to about 3.75%. Is that fully reflecting what the Fed may have to do? In my own view, the Fed may have to be a bit more aggressive than that to put an end to inflationary pressures. Could we see rates in the 4-4.25% range? I think we could and I don’t think that 100% of that is baked in. The July rebound is probably two-thirds right, but one-third wrong. So directionally, I would not be shocked to see a pullback in markets,” says Applbaum, adding that she expects to see continued market volatility to the upside and downside as well.
Applbaum worries about unknowable geo-political conflicts, whether they happen to be the Russia-Ukraine war or tensions between China and Taiwan. “These are less predictable and more prone to accident. Could we see a remedy to the Russia-Ukraine conflict in the form of a compromise? Sure. That will send energy prices lower and ameliorate some of the inflationary pressures,” says Applbaum, who works within a team that includes on the equity side Paul Flynn, Anirudh Samsi and Tomonori Tani, while Thomas Hogh and Robert Neithart are on the fixed income side. “Could we see an accident in the China-Taiwan situation? It is very far from my base case because both parties want to avoid that at all cost. Markets are more cautious. But they have become slightly exuberant of late. It is fair to say that we will see continued volatility.”
Policymakers Shouldn’t Fear Mild Recessions
Noting that the worry of stagflation outweighs recessionary risks because the former tends to be a more difficult environment to navigate out of, Applbaum says, “My hope and expectation is that central banks are students of history and that they understand that dealing with inflation is primary and they should not be overly fearful of a mild recession or political headwinds. I would rather that they err on the side of tighter policy, than looser policy, and risk a rebound in inflation.”
From a strategic viewpoint, the fund is running 11.46% cash, with 27.09% held in fixed income and 61.27% in equities (which is dominated by a 33.48% weighting in the U.S.). The bulk of the fixed income, which is comprised of over 300 individual bond holdings, is in sovereign debt from so-called G-7 countries. “We do have some investment-grade emerging market debt as well,” says Applbaum, noting that the portfolio is primarily investment grade. “But we are not making any big statements in the bond portfolio.” From a duration standpoint, the managers are also being cautious since the duration for the bond portion is slightly under six years, versus 6.9 years for the benchmark Barclays Global Aggregate Bond Index. The running yield for the fund is 0.43%.
On the equity side, Applbaum notes that the managers are bottom-up stock pickers and the sector weightings are a by-product of the stock-picking process. However, the top four sectors are 19.55% healthcare, 16.07% consumer defensive, 14.9% technology and 11.23% financial services.
A Variety of Investment Styles and Approaches
In seeking equity candidates, the managers take varying perspectives on what is attractive. “We use different styles and approaches so that we get a balanced portfolio and not everyone is marching in the same direction,” says Applbaum. “We don’t want all momentum investors or all growth investors or all income and value investors. We really spend a tremendous amount of time thinking through the mix of the portfolio managers on the fund. They are guided by the fund’s objective, which is long-term appreciation of capital, some current income and capital preservation. How they get there differs, however.”
In general, the managers gravitate to companies that are categorized as growth-at-a-reasonable price, are not highly levered, have strong free cash flow and demonstrate prudent capital allocation. “While each one of us may answer the question differently, the fund’s objectives set the guiding principles. We want this fund to be a participant in global growth, and provide stability and not to be on the bleeding edge of volatility if we have a market correction.”
Top Stock Picks
One of the fund’s top holdings is Astra Zeneca PLC (AZN), a British/Swedish pharmaceutical firm that was acquired about five years ago. “When we invested in this company, it had a 4% dividend yield and a low double-digit price-earnings multiple. The market was very focused on patent expirations. But the company made some very interesting acquisitions and partnerships with other companies and now has some very promising pharmaceuticals, which our analysts are enthusiastic about,” says Applbaum. The stock is now trading at 20.85 times earnings, and has a 1.93% dividend yield.
Another top holding is UnitedHealth Group Inc. (UNH), an American-managed healthcare and insurance company that has been in the portfolio for about five years. “When we first invested in the company there was some concern about healthcare management and regulation. But what we saw early was how quickly and how important healthcare management would be,” says Applbaum, noting that the firm is now the largest healthcare management firm in the U.S., thus providing the firm with a wealth of information and data on the U.S. market. The stock is now trading at 28.6 times price/earnings and pays a 1.2% dividend.
Looking ahead about a year, Applbaum argues that while interest rates in some jurisdictions may be higher than the market anticipated, by the end of 2023, “we will probably be approaching a loosening cycle. If you think of investing on a one-year basis, I am optimistic that we will be in a very good position and in a rising market environment,” says Applbaum. “But there will be some volatility and it’s important for investors to continue to invest and to stay the course.”
.jpg)
