How We’re Positioning for Higher Rates and Persistent Inflation
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Back in March, our senior equity analyst, Ali Mogharabi, outlined how the economic consequences of the war could change with its duration. According to Ali:
A relatively short conflict might produce a temporary shock that the economy could absorb;
A conflict lasting six to twelve months could begin putting more pressure on discretionary spending, particularly among less affluent consumers;
A still-longer disruption could affect broader demand and favor businesses with more resilient revenue streams.
We’re now in the seventh month of the conflict, and some of the pressures Ali referred to are starting to take hold. Diesel and other refined-product prices matter well beyond the gas pump. Higher fuel costs filter through freight, shipping, air travel, agriculture, manufacturing, and distribution, raising costs for businesses and ultimately putting additional pressure on household budgets. The longer crude prices remain elevated, the more likely those second-order effects are to show up across the economy.
Overall consumer spending has remained resilient to date, but the pressure is becoming harder to ignore. With inflation running above the Fed’s target for more than five years and the war continuing to keep energy costs elevated, we would expect spending patterns to become more selective before aggregate consumption necessarily weakens. Lower- and middle-income households are likely to feel that pressure first, trading down on everyday purchases and becoming more cautious with discretionary spending.
Add those pressures to an economy that continues to grow at a solid pace, and the result has been several forces pushing interest rates higher. That means tighter financial conditions and a higher hurdle rate for equities, especially for growth companies whose valuations depend heavily on earnings expected further into the future.
In this type of macro environment, we think it’s important to be more selective about the price we pay for future growth. A company can continue growing earnings and still become a less attractive investment if its valuation assumes a more accommodating interest-rate environment.
We’ve been here before. In 2022, rising inflation and interest rates changed the relative attractiveness of many growth stocks.
Our flexibility and active management approach helped on the downside. WestEnd’s Core Strategy declined -9.10%, net of fees that year, compared with an -18.11% decline for the S&P 500.
2026 is not 2022, however, and the scale of our adjustment is different. Nominal economic growth remains solid, corporate earnings continue to expand, and we remain constructive on opportunities tied to AI investment and productivity improvements. But higher interest rates change the math. When investors can earn roughly 5% in long-term Treasuries, the hurdle rate for owning expensive growth stocks rises, making valuation and earnings visibility increasingly important.
In recent weeks, we have reduced selected higher-growth and higher-valuation exposures and harvested losses where we believed capital could be better deployed—building a cash position of roughly 6–7% in the process.
The emphasis is on businesses with more reasonable valuations, clearer earnings visibility, and growth opportunities that are not all dependent on the AI spending cycle. Two names in particular illustrate this shift.
Target
Target is a good example of how we are broadening the portfolio as some of the pressures Ali outlined earlier this year begin to emerge. As higher prices and borrowing costs weigh more heavily on middle- and lower-income households, winning the value-conscious consumer becomes increasingly important. Target gives us exposure to that part of the economy through a company-specific turnaround story with room to recover if execution improves.
Target is working to regain those shoppers through lower prices, affordable store brands, and its loyalty program. It is also investing in the shopping experience and refreshing its merchandise, including areas such as home and apparel where execution needs to improve. These initiatives give us concrete developments to evaluate.
Our thesis also incorporates improvements in stores and delivery, alongside the earnings opportunity in Target’s advertising business. We believe that combination offers room for recovery at a valuation that does not require everything to go right. Dividend income is an additional attraction, but the central question is whether management can translate its initiatives into sustained sales and profit improvement.
GE HealthCare
GE HealthCare adds a more defensive business with a different set of demand drivers. The company supplies MRI, CT, and ultrasound equipment, along with imaging agents, software, and services that support the ongoing use of those systems. That creates opportunities for repeat business beyond the initial equipment sale.
This is the “razor-and-blade” aspect of the model that appeals to us: an installed machine can support an ongoing customer relationship through servicing, supplies, and software. Our research points to that recurring business as an important source of earnings visibility.
We also see an opportunity in the combination of aging populations and AI-enabled tools that can help healthcare providers improve diagnostic capabilities and productivity. GE HealthCare already offers a broad range of AI-enabled devices and digital solutions, giving it exposure to the use of AI rather than simply the construction of AI infrastructure.
China exposure, competition, and tighter hospital budgets remain risks. But healthcare demand is generally less sensitive to rising interest rates than many cyclical parts of the economy, and we believe GE HealthCare’s recurring revenue base and reasonable valuation add a useful source of resilience to the portfolio. At the same time, its exposure to aging populations and AI-enabled healthcare gives the company meaningful long-term growth potential.
In conclusion, we remain willing to own high-growth companies when their fundamentals and valuations justify the investment. We are equally willing to look elsewhere when another business offers a better balance of opportunity and risk. Broadening the portfolio, as we’ve detailed above, is an extension of that discipline—not a departure from it.
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