A rebalancing moment
A reset in equity markets has been underway since early 2022, which has been challenging for investors given higher interest rates, inflation, an inverted yield curve and worries about recession. “These transitions are difficult for investors, [but] towards the end of the year, we found that select growth stocks were trading at compelling relative values,” said Mike Smith, senior portfolio manager of Discovery Growth Equity at Allspring. His team identified companies with strong management teams, positive sales growth, well-managed expenses and prudent capital investments. Given these opportunities, “it’s not surprising to see some mean reversion and positive performance in stocks this year.”
While additional volatility is likely as the market cycle plays out, Allspring’s view is to stay the course and use it as a rebalancing opportunity. “The job of a high-quality investment team is to be consistent and committed to managing through volatility and maintaining style purity,” said Smith, whose team pursues bottom-up stock selection of outperformers that deliver a positive spread to the cost of capital. “As active managers, we can discern opportunities even during periods of capital contraction,” he said. “In turbulent environments, companies may be able to exploit weaknesses in their competition or find ways to deploy capital that are more attractive than during tranquil periods.”
Several equity sectors are likely to outperform over the remainder of 2023, Smith said. “One exciting area of opportunity is within health care, which is a more defensive, less economically sensitive sector. We’re seeing reaccelerating growth in medical devices, for example.” Consumer goods have also demonstrated an interesting pattern over the last two quarters, with several dynamic companies outperforming with new products, distribution growth and innovation, he noted.
Regional trends
Even as global markets grapple with ongoing macro challenges, emerging markets are showing selective potential. “There has been a significant dispersion of returns in emerging markets this year, which is not uncommon,” said Miletti, noting that regions and sectors fall in and out of favor with shifting global macroeconomic factors, currency movements and trade policy changes that are difficult to foresee. When evaluating emerging markets, “rather than trying to predict U.S. interest rate policy, it is far more important to focus on long-term company fundamentals and industry growth prospects,” she said. “This allows managers to ride through short-term volatility and market dispersion and focus on generating long-term value.”
Allspring’s Intrinsic Emerging Markets Equity team is positive on Mexico, which is seeing increased foreign direct investments from Western countries and China and an accelerating “nearshoring” trend. “One CEO there compared the nearshoring phenomenon as important as NAFTA was in the early 1990s. He pointed out, for instance, that if only 2% of China’s existing warehouse capacity were to shift to Mexico, it would double the country’s already substantial capacity,” Miletti said.
The Allspring team is also overweight Southeast Asia, which has seen significant GDP growth and increases in foreign direct investment. Western companies are making more inroads into India, though China has been less aggressive on this front, Miletti said. “Apple, which currently produces 7% of its iPhones in India and the other 93% in China, plans to move as much as 25% of iPhone production to India over the next few years.”
The accelerating shift in FDI flows into and out of China is particularly interesting, Miletti said. China’s economic policy may be moving from Made in China to Made by China in Neighboring Countries. This reflects both an economic imperative, as China looks for lower-cost manufacturing hubs, and geopolitical expediency, as China needs to build influence in Southeast Asia and work around increasingly restrictive trade policy in the U.S. and Europe, she explained. Key Southeast Asian neighbors, such as Indonesia and Malaysia should benefit, and China continues to venture further afield to Brazil and Mexico, she said.
South Africa, on the other hand, is “a market particularly sensitive to global interest rate and currency movements,” Miletti said, and the Allspring team is closely examining key company earnings and macroeconomic drivers for signs of positive change.
Focus on real estate
Another segment to parse with a quality lens is publicly traded REITs, which have historically performed well in high-rate, high-inflation environments. REITs have been under pressure due to concerns over commercial — particularly office — real estate, but there continue to be unique opportunities in segments such as cell towers, data centers and hotels, Miletti said. “During the [COVID-related] downturn, real estate was sold down dramatically and, as a result, some [of these] high-quality REITs became far underpriced and offer opportunity now.”
Smith noted important distinctions between public REITs, private REITs and private real estate. “There’s a large difference between publicly traded and private securities in that public markets are continuous, liquid and transparent [while] private markets are not,” he said. The price reset in public securities that occurred in early 2022 was immediate and transparent, whereas many private assets, including real estate, have yet to go through the adjustment process, he noted.
