Ron Temple: 30-40% chance of recession, but these asset classes can still outperform – David Thornton
Investing was an easy gig last year. Governments were drunk on budget spending, central banks were working overtime to print money, and rates were at zero.
“From February 2020 through the end of 2021, the world’s four largest central banks added $11.7 trillion in assets to their balance sheets,” said Ron Temple, Managing Director, Co-Head of Multi-Asset and Head of US stocks at Lazard Asset Management, during yesterday’s Morningstar Investment Conference.
“That’s the equivalent of $625 million in assets every hour of every day.”
Ecstasy for actions.
But as we have seen, the higher the rise, the greater the fall. The S&P 500 is down 14.5% since the start of the year; the effect of the sum of inflation, supply chain bottlenecks and a war in Eastern Europe that straddles one of the world’s major energy and food arteries.
However, the recession is not won in advance. Temple puts the risk of a recession through the middle of 2024 at 30-40%, with the caveat that most of any error in his forecast would be on the downside. Meanwhile, despite the headline inflation we see today, he expects inflation to average 3-3.5% over the next 3-5 years, starting in 2023.
The perfect place
Temple conceptualizes stocks in terms of the duration of cash flows.
At one end are companies with short-lived, high-value cyclical cash flows, with inflated short-term earnings. At the other end are speculative growth companies that may not turn a profit for a decade.
“I don’t like either end of that bar,” Temple says.
“The problem with high cyclical value, if there’s a 30-40% chance of a recession over the next two years, do I want to be in the companies that have the biggest short-term downside? Probably not. But if I’m in an environment where interest rates are still on the rise, speculative growth companies aren’t a very safe place either.”
The sweet spot might be right in the middle – quality value and quality growth companies, which have maintained high returns on invested capital.
What is the difference between these two categories?
“Quality stock may not be able to reinvest all of its capital generation into growth without depressing its future returns,” Temple said.
He points to consumer staples as a good example of quality value, where excess capital generated beyond what is needed to achieve revenue growth can be returned to investors in the form of dividends or share buybacks.
Quality growth companies, on the other hand, have large addressable markets that can be pursued by redeploying capital.
The story rhymes
If inflation between 3% and 3.5% occurs, as Temple predicts, it might be interesting to examine what stocks did between the tech crash of the late 90s and the GFC, from 1999 to 2009, when equity valuations started from a high base. and inflation averaged 2.7%.
The market has been anemic this decade – 1% growth per year in the S&P 500.
“Owning the market during that decade wasn’t the cheap option, it was the expensive option.”
But there was still the possibility of generating alpha through strategic asset allocation.
The technology industry’s share of market capitalization fell from 25.3% to 14.9%, while sectors like energy and consumer staples rose from 5-13.2% and 6 .5-11.2% respectively.
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