When markets are in a rising tide, all boats (aka stocks) can benefit. When the waters are choppier, active equity selection aims to identify the sounder vessels. Tony DeSpirito reviews five reasons why he believes the new environment is setting up to favor an active approach.
After years of low inflation and interest rates, the economic and market backdrop is decidedly different today. Higher rates have low-risk investments like Treasuries and money market funds offering yields in the area of 4%-5%. This challenges the investment thesis for higher-risk assets such as equities. Yet the long-term picture shows that stocks are still a portfolio’s primary growth engine and have outperformed bonds more often than not across time horizons, as illustrated below. This was the case even as the average 10-year Treasury yield over the 65-year period we analyzed was higher than today, at 5.75%.
But as we discuss in Equity investing for a new era: The return of alpha, the investing backdrop now forming calls for a fresh look at how to gain equity exposure. Higher stock valuations than at the start of the prior regime 15 years ago, plus higher interest rates, means less return from markets broadly (beta) and, we believe, greater opportunity for skilled active managers to generate alpha, or above-market return.
We identify various market dynamics taking shape that support the case for a stock-by-stock, alpha-centric approach to equity investing: