Assessing equity risks in a changing interest rate scenario

The S&P 500 Index may have witnessed one of the greatest bull runs between March 31, 2009, and June 30, 2023, but the path has been bumpy. Vontobel Asset Management opines that the US Federal Reserve’s unending monetary support helped the equity market sail through the rough seas. However, the market scenario is gradually changing, and equity risks are intensifying.

The asset manager says that the massively injected liquidity is being pumped out of the market at a fast pace. “While the Fed may be nearing the end of its hiking cycle, a return to the previously calm environment of low inflation, positive economic growth, and declining and stable interest rates seems increasingly unlikely,” says Vontobel.

According to Matthew Benkendorf, Chief Investment Officer at Vontobel, the unusual condition of the market is the reason why investors find it difficult to distinguish between temporary and permanent growth attributes. This, in turn, makes it hard to pick quality growth companies. 

Besides, several average and lower-quality companies witnessed margin expansion, irrespective of their risk profiles. As per the asset manager, this can expose the investors to new equity risks as the market condition changes. “Diversifying into a true, differentiated, and time-tested high-quality growth at sensible prices approach may be the right strategy for the volatile times ahead,” recommends Benkendorf.

Additionally, Vontobel informs that rising interest rates have created an impact on asset prices globally. This includes the profitability of companies that have relied on cheap financing sources to boost growth, acquire competitors, or repurchase shares. The asset manager contends that margin improvement due to a fall in interest rates can become a thing of the past as the trend reverses.

Grant Bughman, the Head of the Client Portfolio at Vontobel, asserts that in coming times, businesses with genuine competitive advantages, strong structural demand, and good pricing power will benefit more than ever.

Bughman further states that the changing market landscape has also had a significant impact on the performance of active equity managers in relation to the prevailing equity risks. “Strategies that have exhibited lower risk in a world of low-interest rates may, in fact, exhibit higher risk in a world where interest rates have returned to normal levels,” says the asset manager.

“One way to protect from risks ahead is to refrain from focusing on growth to the exclusion of all else. While this approach may exclude some of the fastest-growing companies, we believe investing in growth for the sake of growth is not a great strategy. Profitable growth is,” adds Vontobel.

Read the complete article here.