How To Invest In The New Post-Modern Era

How To Invest In The New Post-Modern Era
Theodora Lee Joseph, CFA

over 1 year ago5 mins

  • Some of the drivers – low inflation rates, low interest rates, low regulations, low political risks, globalization and digitization – which drove the last bull market are set to go into reverse.

  • In a higher rates environment, stock picking and portfolio diversification will be key to beating the market, and value stocks could outperform.

  • Capital-intensive industries could become attractive again as the cost of borrowing increases.

Some of the drivers – low inflation rates, low interest rates, low regulations, low political risks, globalization and digitization – which drove the last bull market are set to go into reverse.

In a higher rates environment, stock picking and portfolio diversification will be key to beating the market, and value stocks could outperform.

Capital-intensive industries could become attractive again as the cost of borrowing increases.

Mentioned in story

The world has rarely seen so much change in a short span of time – a pandemic, high inflation, an energy crisis, and a war. And the things that drove returns over the past decade won’t be the things that drive them in the one to come. Strategists at Goldman Sachs say we are in “a new post-modern cycle” where returns will likely be "fatter and flatter" – that is, with more winners but smaller wins. Let’s look ahead to see how it might alter the way you invest…

What drove returns over the past decade?

Returns in the past ten years – the latter part of the most recent bull market – were some of the best, but also some of the most predictable. You didn’t need to be a genius to do well. You just needed to follow a recipe of buying into US stocks, and overweighting your portfolio on FAANG companies – Facebook (now Meta), Amazon, Apple, Netflix, and Google (now Alphabet). The recipe was successful because of six key factors:

Lower inflation rates: increased productivity, globalization, and technological breakthroughs greatly expanded supply availability, leading to lower prices.

Lower interest rates: the global financial crisis and soft inflation meant that interest rates were kept very low over an extended time.

Lower regulations: supply-side reforms and lower tax rates created a conducive environment for companies to grow.

Lower political risks: geopolitical risk was generally lower after the collapse of the Soviet Union.

Globalization: global trade increased, which helped expand markets and lower costs as companies were able to move facilities to lower-cost countries.

Digitization: devices and people became more connected, enabled by chips and computing power.

What’s going to drive returns over the next decade?

The world has changed significantly in the past few years. For one thing, many of these drivers look set to reverse in a new world order:

Higher inflation: price increases have largely been supply-driven, initially because of Covid-19 supply chain issues. And much of that is fading, but some price pressures are likely to linger as Europe grapples with higher energy costs and slowly exports inflation to the rest of the world.

Higher interest rates: interest rates aren’t likely to be anywhere near the lows of the past decade. Central banks in many large economies have already begun to hike them, and may need to hike more, to try to nudge inflation lower.

Higher political risks: these already have significantly increased following Russia’s invasion of Ukraine, and with the rise in tensions between China and Taiwan.

More regulation: price caps and windfall taxes are early signs governments intend to be more hands-on in the markets.

Greater regionalization: supply chain issues during Covid-19 and brewing tensions between China and the US have resulted in a trend of reshoring, whereby companies bring manufacturing back home, closer to where demand is. This is already happening in the semiconductor industry.

These changes also explain why strategists at Goldman Sachs expect long-term returns in the new decade to be lower and flatter. See, valuations expansion was the main driver of returns but the market can now no longer count on the conditions – ultra-low interest rates chief among them – to drive returns.

Instead, as interest rates increase and begin to weigh on demand, companies will find it tougher to grow. Any growth they do manage will also likely come at a higher cost, not just because of higher interest rates and inflation, but also from steeper capital costs, as they re-shore operations to more expensive regions.

What does this mean for you?

The new environment should change many things, not least how you invest.

This is all good news for people who enjoy doing a little sleuthing when choosing where to invest and who stand by fundamental analysis. One of the characteristics of investing in the past decade was that choosing a winning factor (like growth) or style (like ESG) seemed to matter much more than which individual companies you pick. As the chart below shows, technology and growth stocks outperformed regardless of their profitability, while value stocks underperformed no matter the quality or competitive position of their business.

World value vs growth performance

Without the support of low rates, informed stock-picking will become more important in generating returns that beat the market. The individual performance of the companies you choose to invest in will matter most, not the performance of their overall sector. So you might want to start focusing on identifying companies with strong competitive advantages and resilient cash generation.

You might also have to start really diversifying your portfolio. Last decade’s winners were those who relied mostly on US and technology stocks to drive returns. In this new era, a wider variety of sectors may outperform – and those FAANG 1.0 stocks could easily be replaced by FAANG 2.0, as I wrote about here.

And it may be time to revisit Seth Klarman’s all-weather “margin of safety” advice (basically: buy stocks cheap). In the weird world of the past decade, that advice fell by the wayside as expensive stocks kept getting more expensive and as cheap value stocks languished. Now if interest rates are expected to remain high with upside risks, then it also means there’s less chance that rapidly expanding valuations will be a key driver of returns. That puts a fresh shine on value stocks.

And, finally, keep an eye on capital-intensive industries like resource companies or capital goods companies. Part of the reason why they underperformed in the past decade was that they had seen one of the main barriers to entry – high capital requirements – eroded by low interest rates. Because capital was cheap, many companies could throw money at chasing unprofitable growth. Now as growth becomes more expensive, it will also become more scarce. Capital-intensive industries like oil and gas could benefit from tighter supply, especially after a period of ESG-led underinvestment.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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