By almost any measure, this has been a difficult year for investors. Surging inflation, rising interest rates and outsize selling pressure in certain sectors, particularly technology, have caused sharp declines in market indices.
As the principal investment officer of Capital Group Private Client Services, I want to share some thoughts on the stock market environment and especially how our team is approaching it. Let me start by saying that I understand how unnerving these periods can be for clients. Moments like this can raise unsettling questions, often involving some variation of: Is it different this time? In other words, are the forces pressuring stocks somehow unprecedented or uniquely insurmountable?
The answer, in my opinion, is a simple no. I’ve experienced six bear markets in my career. They occur for a variety of reasons. It’s important to understand those reasons and, like today, to take them seriously. At the same time, it’s essential to remain grounded and avoid overreacting. History has shown bear markets to be relatively rare. When they have occurred, stocks have eventually recovered and gone on to new highs. I believe that will be the case today. Beyond that, down markets can create opportunity, both by reducing excessive valuations of attractive companies and by turning a spotlight on the industries and companies that may shine in a subsequent rebound.
The first rule my team and I follow in these periods is to stay focused on the proven investment approach that has served Capital Group clients so well during our more than 90-year history. We strive to maintain a clear-eyed view of emerging economic and financial conditions. We pair that with deep experience in navigating through previous bear markets. As important, our analysts around the globe remain committed to thorough fundamental research, examining companies one at a time to try to identify those with truly superior long-term prospects.
Naturally, we pay close attention to circumstances as they evolve over time. This issue of Quarterly Insights details some of the shifts underway in the economic, monetary and geopolitical landscape. Our entire team spends a great deal of time assessing all the factors affecting businesses. Not surprisingly, we are meeting with more companies than ever — in person, whenever possible — not only to see how they are faring but to gauge how they are situated for the future.
To give a sense of the market today, it helps to compare it to last year. Though stocks surged in 2021, a handful of tech giants led the advance. As the year progressed, our investment team grew increasingly concerned about their extraordinarily high valuations. Even companies with bright prospects face uncertainty and challenges. Yet these businesses were priced for perfection.
For that reason, our U.S. Equity Service had below-market tech exposure. To be frank, that positioning dented investment results last year and played a big part in how our relative returns fared in comparison to their benchmarks. Conversely, that same positioning has benefited results so far this year.
I remain optimistic about tech long-term. But given the near-term outlook, I’ve made some adjustments in the portfolios I manage. For example, semiconductor demand surged during the pandemic as housebound consumers stocked up on electronics, internet-connected exercise equipment and TV streaming services. But the excitement may have been overdone, pulling forward demand from the future. Equally important, the chip industry faces production and supply chain impediments. Given the potential for all of this to impact profit margins, I’ve lightened my chip exposure.
Going forward, I don’t think big tech stocks will dominate as they have in recent years. Instead, I expect that the rest of the market, including industries that may have been overlooked or overshadowed, will play ever-more meaningful roles.
One of the sectors I am drawn to at the moment is aerospace and defense, including travel-related companies. I continue to hold positions in defense companies and components suppliers and servicers. I also have initiated positions in select airlines. Anyone who has traveled recently knows that planes are packed with Americans embarking on long-delayed vacations. There are also natural constraints on supply based on equipment and especially labor. The net benefit to airlines starts with pricing power.
In some ways, health care falls into the category of overlooked sectors. Last year, investors favored high-octane growth businesses on one end and cyclical companies anticipating an easing of the pandemic on the other. Health care didn’t fit into either camp. But there are a number of companies with top-flight research and promising drugs in development.
Going a step further on biotech, I believe it’s a good example of a beaten-up industry offering significant value. Biotech soared early in the pandemic amid broad excitement over potential COVID-19 vaccines. But it has gotten hit very hard in the past year, partly because investors grew nervous about companies that burn through cash for years with no guarantee of their products achieving commercial success.
The selloff has ensnared a number of promising young companies that may be appealing takeover targets for established pharmaceutical companies seeking to beef up research pipelines. Years ago, I was a bank analyst when many large financial institutions acquired smaller competitors to expand market share and fill out product offerings. I believe a similar dynamic may take place with biotechs.
I want to close where I began, by saying that I understand how stressful down markets can be. But I believe troubled periods can also spell opportunity for investors with patience and discipline. My team and I will continue working hard to identify companies that we believe will serve our clients well in the years to come.