Capital Group portfolio manager sees continued era of higher inflation

A higher-inflation regime for stock markets is here to stay, and that means there's likely to be a new round of winners and losers in equities, said Lisa Thompson, equity portfolio manager for Los Angeles-based Capital Group, with $2.1 trillion in assets as of Sept. 30.

In a presentation Thursday at the New York Stock Exchange, Ms. Thompson outlined her views on where stocks are headed; she manages Capital Group's New World Fund, Capital World Growth and Income Fund, and International Growth and Income Fund.

"We take a longer-term view of five to 10 years. This environment will have more inflation than the post-global financial crisis period. It (inflation) may come down in the short term, but in general, we are in a higher inflation regime than in the past 12 years," Ms. Thompson said. "We're not going back to 2017 prices."

That has implications for stock-picking going forward.

"We've all grown up in a disinflationary environment for the past 30 years," and in a new inflationary regime, that requires "looking for new winners."

Megacap technology companies, for example, have had a tremendous run over the past decade, but the potential for major growth isn't as likely, Ms. Thompson said.

"These larger companies are more economically sensitive. Internet advertising is mature, plus there's competition such as TikTok."

Instead, "we're looking at midcaps that can grow 20% a year for the next 10 years going forward."

She declined to mention specific company names, as per firm policy, but recalled an example of a one-time tech winner: "Remember when Cisco was one of the largest companies in the world?"

A peak in the Federal Reserve's fed funds interest rate "is in sight," said Damien McCann, a Los Angeles-based Capital Group fixed-income portfolio manager, at the same presentation.

He estimates the fed funds rate will approach 5% by May 2023.

That should lead to an even steeper yield curve inversion than today, Mr. McCann said.

Historically, "We have to go back to the early 1980s for a comparable yield curve inversion," he added.

As a result of inflation and rising interest rates, institutions such as pension funds, endowments and other investor clients this past year have expressed more interest in dividends, said Ms. Thompson, who is based in New York.

"In a disinflationary era, growth was where everyone wanted to be. But if we're in a high-inflation era, we like to invest more in (companies with) high fixed assets," such as real estate, telecommunications, banks and other financials.

Commodity prices may come down in the near term, but "will trend higher in the long term," keeping inflation as part of the market's backdrop, she said.

"And remember, we're seeing inflation even with China flat on its back," she added.

Ms. Thompson is also keeping a close watch on demographics, which "affects labor markets globally. With the WTO (World Trade Organization agreements) we had low-cost labor around the globe. That's been exhausted. And COVID accelerated that labor tightness."

Deglobalization should continue amid geopolitical tension between the U.S. and China, the war in Ukraine and continued bouts of COVID-19.

"Everybody went for scale in their business" in prior years, relying on just-in-time inventory, Ms. Thompson said.

"Now companies need diversified supply chains. China is also seeking self-sufficiency. We're seeing it in Europe looking for their own LNG (liquefied natural gas) supplies and the U.S. with semiconductors," she said.

The world's largest foundry, Taiwan Semiconductor, in late November said its new chip fabrication plant in the state of Arizona is complete, and will make semiconductors for Apple.

And a result of decarbonization, investors will seek new sources of energy and likely drive up prices for wind turbines, solar, rare earth metals needed for batteries and other alternative power sources. "Inflation will likely be higher as a result," she said. "And we will see which companies have pricing power."