Daniel Strickberger

The primary catalyst for a market rally is lower inflation, not aggregate market earnings according to Daniel Strickberger, Chief Investment Officer of DSM Capital Partners. Lower inflation will reduce the need for further rate increases, improve the economic outlook and raise the market’s Price to Earnings multiple. Even with the inherent risks of various global crises, as October began, DSM saw light at the end of the tunnel and felt the market’s risk versus reward favoured the buyer.

Dan Strickberger, CIO and founder of DSM Capital Partners, has been warning clients about inflation since early in 2021. “In the United States, unprecedented economic support from the federal government, including the possibility of an additional $1.5 trillion dollars from the Biden Administration, combined with a very accommodative Federal Reserve and the reopening of the global economy, may lead US GDP to possibly exceed 5% growth in 2021.  However, this combination of strong economic growth and massive fiscal stimulus has resulted in concerns that inflation could eventually exceed the Federal Reserve’s 2.0% – 2.5% target, which may lead to higher interest rates and correspondingly lower valuations on stocks.”

With inflation as measured on a 12-month basis at a thirty-year high in mid-2021, DSM explained that if inflation remains above 3% for an extended period of time, interest rates may rise higher than currently expected.  They further noted that “if rates do go up more than expected, we believe positions with loftier P/Es will be at a greater risk of a significant correction.”  As a result, DSM began to trim or sell higher P/E names and to purchase or add to positions with lower P/Es.

As 2021 wore on, DSM continued to find it troublesome that some Federal Reserve and ECB members were seemingly unconcerned that inflation over 4%, driven by rising commodity costs, rapid wage increases and labour shortages, was not a problem. While Dan and the team felt it was too early to conclude that inflation was there to stay as of year-end 2021, they would prepare for that risk by continuing to avoid excessively high valuations and (as they always have) cyclical investments.

During the first quarter of 2022, DSM continued to maintain a more cautious portfolio approach as the outlook for inflation, and therefore rising interest rates, remained uncertain.  However, within this uncertainty, DSM also saw opportunity stating, “we believe that rising interest rates over the coming quarters may result in higher market volatility thereby creating attractive buying opportunities for intermediate/long-term investors.”  As a result, DSM focused on identifying new investment candidates whose business fundamentals over the intermediate to longer term remained strong, but whose valuations had declined significantly, providing a very attractive entry level to drive future returns.  Over the ensuing months, the firm’s diligent research process led the team to identify a range of reasonable valuations for oversold quality growth companies, particularly in the technology/digital/software arenas, which were opportunistically added to the portfolio.

With many central banks raising interest rates as of mid-2022, equity markets (and other asset classes) declined as they systematically corrected the valuation distortions fashioned by artificially low interest rates over the last decade.  By early October, Dan began to see a light at the end of the tunnel as the year-over-year growth rate of M2 money supply fell below its historic sixty-year average level.

Several months later, he believes that the light at the end of the tunnel in global equity markets is growing even brighter.  “In our view, the drop in money supply growth over the last several months (as measured by M2), has led to a slowdown in inflation as measured by the CPI, PPI, and PCE monthly releases. It appears that the declining growth of M2 may, once again, be a leading indicator of lower inflation.”

DSM continues to make opportunistic purchases of a number of new securities characterized by leading market positions, sustainable technological advantages, few potential new competitors, little pricing pressure, long runways of revenue growth, and stable cost structures, all of which they believe should lead to predictable earnings growth.

In the firm’s view, ongoing rate increases by the Federal Reserve and ECB will continue to lower inflation. Once clear signs of persistently declining inflation emerge and central bank rate increases are indeed paused, DSM believes we may well see a bullish response from global equity markets. As Dan says, “there is an ever-brighter light at the end of the tunnel.”

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