According to the artificial intelligence (AI) chatbot ChatGPT, the pivotal issues in equity markets today include geopolitical shifts, technological advancements, interest rates, inflation, trade disruption, environmental issues, and regulation. 

That is a long list for investors to be mulling over and potentially one that could cause some anxiety. But Walter Scott’s Alan Edington thinks it is practically impossible to predict when pivotal moments could strike and the potential disruption they could cause. 

He argues rather than worry about that, a sensible approach in a volatile and unpredictable environment is investing for the long term in resilient companies. “Trying to time market crashes is really hard, no one does it well,” Edington says. “We think it is sensible for equity exposure to be a meaningful part of portfolios for the long term.”

Interest rates and inflation

Turning to ChatGPT’s pivotal moments of inflation and interest rates, Edington notes despite both being higher than in recent history, there has been a consumption boom since the global pandemic. But that shows signs of slowing.

Source: New York Fed, Center for Microeconomic Data, Household Debt and Credit 2023 Q3 report, as at November 2023

“We have exhausted Covid savings, we have funded a consumption boom and started reverting to credit cards to fund lifestyles,” he adds. “Credit card delinquencies in the US are starting to tick up²  which tends to be a sign that consumption is likely to slow in the future.”

Edington argues in an environment of slowing consumption it is pragmatic to be exposed to profitable companies because high profitability indicates a company’s products and services are in demand.

Additionally, he says pricing power is important for a company to be able to pass through the effects of inflation, as is having a strong balance sheet. “The one thing you don’t want in a higher interest rate environment is your company not being able to invest for future growth because borrowing costs are too high,” he adds.

Technological advancement

The adoption of AI and its application across industries has been a driving force in equity markets, not least in the US where a handful of large cap technology stocks have led certain indices. Edington suggests it is valuable to assess the potential threats and opportunities from AI to companies’ businesses models.

“It is important to work out if companies’ business models will be displaced or their competitive advantages eroded,” he adds. “Then look at the portfolio to assess whether it is geared into this area because there is no doubt AI will drive earnings growth for lots of businesses over time.”

Walter Scott is seeing opportunities from AI in areas of healthcare, automation, and search and advertising among others. One company Edington highlights is Intuitive Surgical which produces high-precision surgeon-operated robots. The newest company offering will provide surgeons AI-driven coaching and analysis on operations, and robots that can provide nudges during a procedure based on proprietary historic data to provide the best outcomes.

Geopolitical shifts and trade disruption

Geopolitics remains influential in global economies and markets, Edington says. He thinks the tension between the US and China is currently the most pertinent geopolitical force in financial markets. 

He notes the semiconductor ecosystem offers an interesting case study in geopolitics. China and the US are trying to diverge and that is spreading to other nations in the world as certain countries spend meaningfully to gain independence in the race around semiconductors, he says.

Edington explains: “In terms of designing software and equipment, the US, Japan and Europe dominate. But when it comes to the fabrication of semiconductor chips, Taiwan and China are big. Each country wants to do what the other does. China is desperate to design its own chips while the US, Japan and Europe are building factories in their own jurisdictions because they want self-sufficiency in this space.”

On China more broadly as an investment destination, Edington says there are reasons to be concerned, including political and regulatory risks. Walter Scott, he adds, prefers being exposed to developed market companies that derive revenues from China and other areas of Asia. “You’ve got a growing middle class with aspirational consumers who are willing to spend,” he adds.

One company example is Asia-focused life insurer Prudential. Edington says as Asia’s middle-class expands, there is likely to be growing demand for life insurance and protection products. “China’s not broken, you just have to select the right pockets of secular growth,” he adds.

Environment and regulation

Regulation is making it increasingly complex for businesses to operate, says Edington. One area of opportunity here, he adds, is in companies that act as enablers for businesses and individuals to prepare and cope with regulatory changes.  

An example is Wolters Kluwer which produces software and services around regulation for professionals like lawyers and accountants. Edington notes the company has an asset-light business model, and a subscription model makes it a steady and consistent generator of cash.

When it comes to environmental issues, Edington says there is closer scrutiny on companies’ carbon footprints. In relation to this, he flags Dassault Systèmes, a French software company that creates 3D digital worlds and scenarios that can help companies plan and execute a more sustainable operating model, including how to deal with a product’s end of life, recycling and reuse.

The importance of earnings growth

Coming back to ChatGPT’s pivotal issues, Edington concludes: “If markets are pivoting, if the world is changing, what sort of companies should we invest in? Trying to time when pivots and issues will appear or how they will affect economies and markets is impossible. 

“We think earnings growth drives share prices over time – as long as you don’t pay too much. Therefore, we look for companies where earnings growth is not going to be disrupted by the various pivots and issues in markets and where companies can benefit from secular growth trends. Doing this requires investing in companies that are positioned not just to grow but to be resilient when a change in environment occurs.  That means investing for the long term with exposure to highly profitable companies with pricing power and strong balance sheets.”

The value of investments can fall. Investors may not get back the amount invested.