It’s time for a new playbook for investing in a bear market.
That’s according to John Linehan, chief investment officer at
T. Rowe Price
“Bear markets are a lot like Tolstoy’s unhappy families. No two are alike,” Linehan said at a news conference. “We really need to throw conventional wisdom out the window when we think about what markets are going to do over the next year, and indeed, the next decade.”
The first “truth” to be discarded is that investment in growth will once again take the lead. As Linehan sees it, value stocks look cheap and relative fundamentals have improved. While there are still “very solid expectations” that growth will outpace value going forward, “we think those expectations could be disappointed,” she said. “When we think about the environment we’re in, a higher interest rate environment means that shorter duration assets such as value should perform better.”
This year, the value is crushing growth by one of the biggest margins in years. The
S&P 500 value index
it’s down just 4.7% this year, versus a 25.7% decline in
S&P 500 growth index
Linehan, who is also a portfolio manager of the $17.2 billion
T. Rowe Price Equity Income Fund
(PRFDX), expects interest rates and inflation to remain elevated and valuations to matter more going forward than they have to date. “We think having a balanced portfolio and having both growth and value represented in the portfolio is probably the best path forward.”
Linehan said he was “pretty neutral” on energy — the best-performing sector this year — given where oil prices are today, and rejected the notion that the world is permanently moving away from fossil fuels.
“We have dispelled this narrative that the world doesn’t need hydrocarbons or energy at any point in the near-term future,” he said. “The significant disruption we’ve seen in Europe, as Europe has been forced into an energy restructuring to wean off Russian gas, I think is a model for the risk associated with us ignoring the energy industry or not realizing the importance [it can] play in the global economy in the next decade”.
He noted that oil prices around $90-100 a barrel are not sustainable unless there is a significant geopolitical upheaval, as we saw earlier this year when Russia invaded Ukraine. “At the same time, the free cash flows that have been generated in the energy sector allow these companies to be much more investable tomorrow and today than in the past,” added Linehan.
A second truth to ignore is that in a recession, banks underperform. The problem with that thinking this time around is that it “goes back to fighting the last war,” Linehan said. The banking sector is very different today than it was before the 2007-2009 global financial crisis (GFC), she noted. Nowadays, banks are better capitalized, have greater regulatory oversight and higher underwriting standards. “They’re less susceptible to very significant credit hits in the way they weren’t during the GFC.”
A third truth that may not hold up this time around is that consumer staples are a great place to be in a downturn as they offer very defensive characteristics. “We believe that in a higher inflation environment, consumer staples are under more pressure as they have to pass on significant cost inflation in terms of the cost of their inputs that they go to sell,” Linehan said. “As a result, their profit margins have been squeezed and they don’t provide as much protection in an inflationary environment as they do in a less inflationary environment.”
The fourth truth Linehan rejects is that investors should avoid Europe when the US dollar is strengthening. The greenback has rallied this year against a basket of major currencies.
What investors don’t see in avoiding Europe is that European companies “are much more competitive today with a stronger dollar and a weaker euro” and that US companies “will struggle in terms of revenue growth as a weaker euro and a stronger dollar will depress revenue growth outside the US”
The fifth truth to question is that failing companies should be avoided. Linehan has turned this thinking upside down. “Decade of disruptors can give way to decade of disruptors” and just watch the video stream and
(ticker: NFLX), he said.
“The last decade has really been a decade where Netflix has built an amazing market for streaming services, and until recently, it had that market to itself,” Linehan said. “But what we’re seeing most recently is a very significant competitive response from a number of discontinued companies,” including
+, Walt Disney’s streaming service (DIS),
) and Peacock, the streaming service owned by NBCUniversal’s unit
), among others. “We think this trend and dynamic will continue across a variety of different industries. “
Email Lauren Foster at email@example.com