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December 2023 / INVESTMENT INSIGHTS

Seize the opportunities in a new era for global equities

Evidence points to a new equilibrium path for equity investors to follow

Key Insights

  • After an extended and unusual period of low inflation and ultralow interest rates, we now appear on a new equilibrium path. One where inflation remains sticky and interest rates are higher. 
  • Being on a different path will offer different opportunities in the future. Having a broad definition of growth flexible enough to focus on new areas of the market will be key.
  • Our investment framework remains focused on identifying quality companies where we have insights into improving economic returns in the future but we do not pay too much for them. 

In 2023, investors have had to contend with multiple headwinds that could have combined to derail equity markets. Among them, a regional banking crisis in the U.S., a severe slowdown in China, and wars going on in Ukraine and the Middle East. Add to that 500 basis points of cumulative interest rate increases, a deeply inverted yield curve, and a litany of other gloomy economic indicators. Yet, while there have been bouts of volatility, equity markets have held up surprisingly well. Large‑cap technology companies—in particular the so‑called Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta Platforms, and Tesla)—have fared even better. 

What’s behind the apparent contradiction? In the U.S., economic growth has consistently exceeded expectations, pushing out a highly anticipated recession. We also haven’t experienced a “normal” credit cycle. In the U.S., companies and consumers alike have termed out their debt over the last few years at extremely low levels of interest rates. Fiscal policy, meanwhile, has bolstered the economy through infrastructure spending, in numerous cases for geopolitical considerations, and in stimulus measures to help during the coronavirus pandemic. Consumers have reaped the rewards of higher savings and accelerated real wage gains, while at the same time locking in low rates on their largest expense—mortgages. Simply put, the Fed rate hikes have been nonbinding and haven’t impeded the economy in a material way. How long this will last is an entirely different question, but it is how we got here today. 

A new equilibrium path for equities?

Our view is that we are operating in a different environment from the one that supported equities for much of the period after the global financial crisis. The equilibrium path has changed—and equity investors need to adapt. 

Between the global financial crisis through to the coronavirus pandemic, the equilibrium path was deflationary—low inflation created even lower inflation. This was demonstrated in the energy sector as the low cost of capital and technological revolution of fracking led to increased drilling and more oil being sold at lower prices. A cycle of lower inflation and lower rates created a continuous feedback loop of abundance. The dynamic was not isolated to the oil and gas industry. It extended across sectors and economies and created a paradise for growth investing—especially for those investing in duration.

The cycle has shifted, and we now appear on a new equilibrium path. One where we see inflation remain sticky, despite recent falls, and with interest rates being maintained at higher levels for longer. The global financial crisis shocked us onto a lower inflation and lower rate path. Now, the pandemic, fiscal policy response, and supply chain problems have shocked us onto this new path—one that is likely to lead to a continuous feedback loop of scarcity.

Again, we highlight the oil and gas industry, where even though oil prices have risen solidly since the summer 2023 trough, rig counts in the U.S. are falling. Why? Because rising financing costs; labor shortages; higher transportation costs; environmental, social, and governance (ESG) pressures; and industry consolidation have all pushed the oil cost curve meaningfully higher. This requires oil prices to be higher to incentivize companies to accelerate drilling. 

These dynamics set the scene for inflation to remain sticky, alongside higher interest rates, until we get shocked off this path. This would require a recession and high unemployment, but that is not predicted in the near term. With the U.S. Federal Reserve unable to create a credit cycle, but also unlikely to aggressively cut rates leading into an election year, we expect higher short‑term rates for longer until the excess liquidity from the pandemic is pulled out of the system. 

 

Download the full report here:(PDF)

IMPORTANT INFORMATION

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

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