He acknowledges that the inflation fight is not over, but says a pivot from the Federal Reserve does not have to involve rate cuts; the Fed keeping rates on hold for a period or even reducing the size of the super-sized increases it has delivered recently would represent a change in direction that the markets are likely to embrace.
He has noticed a few signs of a shifting mood in the markets recently, from signals that turbocharged inflation rates in Brazil have peaked – sparking a rally in the country’s small and mid-cap stocks – to a greater number of institutional investors positioning for a potential end to deep risk aversion.
hedging effect
When the Global Select Fund started investing in a beaten-down healthcare stock recently, it jumped about 10 per cent just as Richyal started buying. His market soundings suggested the move was driven by a degree of short covering as well as by hedge funds getting long.
“Because everyone’s so hedged, there might be a fear that the pain trade is up, and then you might get a scramble to actually reposition long.”
That would be good for Richyal’s portfolio, which is dominated by long-duration stocks, which were beaten up in the first half of this year but are now rising off their lows. He says it’s time for investors to start looking at higher-quality stocks in parts of the market that have been heavily sold during the past six to nine months, such as technology.
“Some parts of the market really have already suffered. That doesn’t mean that the index at an aggregate level can’t come down further, and it doesn’t mean that some pockets can’t de-rate further.
“But if we start to gravitate towards those parts of the market that have had the pain, and are stabilizing and where you’re seeing some fundamental improvement, it is the right thing to do right now.”
The market has clearly soured on recently listed tech companies and those that went public in the past few years, either via floats or during the SPAC craze of 2021. But Richyal is looking for nuggets here, too.
“This is the correct time to sharpen your pencil and find an IPO that’s actually a good quality company but the baby has been thrown out with the bathwater,” he says. “Because there’ll be some pretty solid businesses over the next five, 10, 15 years who may just have derated because they happened to IPO at exactly the wrong time, or they happened to de-SPAC at exactly the wrong time.”
Richyal and Lees’ cautious optimism appears to be catching. Legendary hedge fund investor George Soros has also been buying tech stocks, loading up on Amazon, Salesforce and Google’s parent Alphabet such that all three are now among his 10 biggest holdings.
According to Bank of America, their US clients have been net buyers of stocks (that is, more buyers than sellers) for six consecutive weeks, with institutional buyers leading the way in the last two weeks. Tech stocks have been particularly popular – last week had the biggest weekly inflows to the tech sector since 2008.
As BofA says, there is risk in this tilt to tech; Although the June quarter earnings numbers for US tech giants held up reasonably well, there are questions about whether these stocks will prove quite as defensive as investors think, particularly as US economic growth slows further.
And as this column has been banging on about for months, the excesses of the past decade, let alone of the past few years, look a long way from being washed out of this market.
inflation outlook
But even if investors feel the recent market momentum is unwarranted – the S&P is now up 16.7 per cent since its low in mid-June, the Nasdaq Composite is up 22.6 per cent and the ASX 200 is up 9.3 per cent – they need to be at least considering the idea that the market has bottomed and risk- on sentiment can keep running for a while.
How long sentiment remains robust will probably depend on the outlook for inflation. The Fed has made it clear that inflation remains uncomfortably high and interest rate increases will be needed well into next year. It will be worried about rising equity markets too, as this loosens financial conditions.
But investors in bonds and stocks are effectively shrugging their shoulders and betting that the Fed will take its foot off the interest rate accelerator to engineer the sort of soft landing in which the US avoids a recession.
Richyal is watching inflation too, although not for the reasons you might think.
“We still think that even though some of the strongest disinflation trends may be coming to an end in certain cases, the most important trend – demographics – is still going in the same direction. We are still living with aging societies, regardless of whether that’s west or east, global north or global south. And that primary trend is going to overwhelm most other trends.”
Many economists argue that aging populations will be inflationary: the trend of fewer workers pushes wages higher, and consumption of healthcare and similar services explodes. But Richyal has a somewhat contrarian view.
As the population ages, older people will tend to downsize where they live, meaning investment in fixed assets (particularly property) actually falls. The experience of Japan, which Richyal describes as “an ideal petri dish” because it has had a rapidly aging population and has been battling deflation for decades, suggests “that decline in fixed asset investment means you don’t actually need that many people” .
Richyal also borrows from work done by Australian economist Gerard Minack, who was previously Morgan Stanley’s chief global investment strategist and says the data disputes the idea that a reduced workforce pushes up wages.
“The key to the aging-is-inflationary argument is the assumption that falling labor supply leads to increased bargaining power for labour,” Minack wrote last year. “Japan shows the reverse applies: fast labor supply growth went hand-in-hand with fast wage growth, then slowing labor supply growth slowed wage growth.
“Japan is not exceptional. Slowing labor force growth is a cause of, not an antidote to, secular stagnation. It is a false hope to think that aging will end secular stagnation. And neither Japan nor the US is exceptional: the link between demographics and disinflation is obvious elsewhere.”
Richyal does see risks to his argument, particularly around the appetite for borrowing in the economy; if this is considerable, persistent inflation is possible.
But the power of deflation from aging is such that he believes “we could just end up in Goldilocks again, where it’s just not too cold, not too hot, because these forces all just wash each other out”.
If that’s the case, Richyal believes investors will want long-duration stocks such as those he owns – high-quality tech and healthcare companies that investors will reward for delivering growth in what he believes could be a low-growth, deflationary world.