Higher inflation has been at the forefront of institutional investors' minds because it signals how much further rate hikes will need to go, said John R. Mowrey, chief investment officer of NFJ Investment Group, which focuses on value equity investing.
Specifically, services inflation has been "stickier" than either market participants or the Federal Reserve had expected, noted Mr. Mowrey, who is also executive managing director and senior portfolio manager/analyst at the firm, in an email.
However, Fed tightening does not necessarily bode ill for stock markets. Mr. Mowrey pointed out that in the 14 Fed interest rate hiking cycles since 1970, only three such periods saw equities fall as the Fed raised rates. "This means 78% of the time, when the Fed is hiking, stocks are rising," he added.
Looking at historical precedence, Mr. Mowrey thinks the U.S. economy might avoid a recession this year.
Going back to the World War II, he noted that whenever the S&P 500 index declined by as much as it did last year (-18.1%), only three times did the index suffer a subsequent decline the following year.
"Given this historical upward bias — we are more optimistic," Mr. Mowrey said. "In addition, while a recession sounds scary — we believe a lot of this bad news was discounted last year."
Mr. Mowrey concedes that the strong job market creates a challenge for the Fed.
"Because rates have been moved high so quickly, M2 (the growth rate of M2, the money supply) is now negative," he said. "The combination of higher rates and M2 going negative means slowing nominal GDP, which suggest both inflation and real GDP will slow. The market will welcome this."
For now, Mr. Mowrey believes high-quality cyclical stocks offer better values than defensive names.
Within the health-care sector, life science companies are "positioned well," he said. "They are trading at some of the steepest discounts since March 2020, have clean balance sheets, high margins and pricing power," he added.
Also, real estate investment trusts look "very attractive" as the high interest rate environment has "created a dislocation" in valuations due to higher cap rates.
Not all REITs are buys, Mr. Mowrey cautioned, but he is seeing opportunities among public REITs such as storage REITs and residential REITs.
Mr. Mowrey added that emerging markets are not getting enough attention from U.S. investors as they are currently "on sale" with the 20.1% plunge of the MSCI Emerging Markets index last year.
"The strong dollar has helped create this dislocation," he explained. "The last time the dollar was this strong was October 2001."
Emerging markets stocks have been a strong long-term performer. He pointed out that if investors started investing in emerging markets stocks back in October 2001, they would have outperformed the S&P 500 index by 100 basis points per year on average.
NFJ, which serves both institutional and retail clients, has about $6.8 billion in assets under management.