How investors can find returns amid scarce global growth
UK growth in the last six months of 2016 was better than expected at 0.6% but in the Chancellor’s last Autumn Statement, the UK growth forecast for 2017 was revised down from 2.2% to 1.4%.
David Coombs, manager of the Rathbone multi-asset portfolios, says that in the US despite what President Donald Trump says, growth is unlikely to double to 4% this year, and global growth looks “similarly sluggish”.
For Adrian Lowcock, investment director at Architas, with Brexit negotiations not even started, the growth figures are “not particularly useful” and at present, it’s very difficult to forecast growth in the UK.
However Lowcock says even if forecasts are wrong, it is evident there is slow growth in the UK and in global markets.
“The main cause of the slowdown in growth expectations is the impact Brexit negotiations will have on the UK economy, particularly as foreign companies delay or cancel investment,” he says. “So far the economy has held up as consumer confidence has remained strong and a weak pound has helped businesses in the UK.”
In a low growth environment this makes it more difficult for investors to find returns. Lowcock explains: “Ultimately if there is less growth then company profits are less likely to grow, except through competition where there are winners and losers. If companies are not growing as quickly their shares will not rise and could fall. And then there is inflation to consider. Companies will need to grow their profits above any rate of inflation, which is currently on the rise.”
Hugh Yarrow, manager of the Evenlode Income fund, says that pay-out ratios for the aggregate market have fallen over the last few years and revenue growth remains relatively low owing to patchy economic backdrop.
He says: “Corporate debt levels have also been rising, as companies have used low borrowing costs to help fund acquisitions and shareholder returns. Offsetting these factors last year was the significant depreciation in sterling, which is helpful for UK companies that earn and/or pay their dividends in foreign currencies. This led to a modest increase in dividends for the aggregate market last year, but without this currency benefit dividends would have fallen.”
How investors can gain returns in the low growth environment
Coombs says he will continue to focus on companies with strong brands, high cash flow yields and low debt, particularly as those businesses have become cheaper since Trump’s victory.
“Companies that can rely on steady streams of cash have options in difficult times, and those that can raise prices without losing market share tend to be better protected against inflation. We hold companies that we believe have both attributes, including Alphabet, Visa and Nike. We find most quality global companies are based in the US, which is why we continue to have a bias to North America.”
He says Alphabet (Google’s parent company) will be a primary beneficiary of the secular shift to online spending and the company is still early in their monetisation of mobile ads. Coombs says the business has stronger capital discipline since the appointment of the highly regarded CFO several years ago.
On Nike, he says it’s an “excellent brand” with ongoing innovation; strong positioning in running and basketball and has dominant market share in US. He adds: “Its direct to consumer business is growing rapidly which supports margin expansion.”
Visa volumes are rising and there’s plenty of scope in the US for the cash-to-card switch where it is 40% below global usage. Coombs says: “Visa looks expensive, but this compresses very quickly. Moreover, confidence in the growth is high.”
Lowcock says in the UK cyclical stocks currently look attractive as they have been discounted by the market for a number of years and have looked cheap.
“But the reason for this is partly driven by an expectation that Trump will deliver a fiscal boost, which would benefit the US and in turn the UK. The impact would be to create greater inflation and therefore interest rate rises.
“The fact the UK economy hasn’t crashed post Brexit, combined with a weaker pound and rising oil prices, has led investors to reassess their views on sectors such as banks, housebuilders and energy stocks and take a more positive view.
“Defensive assets which were popular for many years following the financial crisis (think bond proxies; tobacco, pharmaceuticals, utilities etc) have been sold off, as investors rotated from these into the cyclicals mentioned.”
He says this could carry on for some time, even if growth slows down in the UK. “However staying invested in those defensives longer-term should benefit investors. These companies generate decent earnings and earnings growth as well as offering dividends and inflation protection,” he adds.
Yarrow remains focused on competitively advantaged businesses with strong balance sheets and cash generation.
“Companies with these characteristics tend to be good at producing healthy dividends through a wide range of economic outcomes. Key sectors for the Evenlode portfolio include consumer branded goods, technology, media, support services, healthcare and engineering.”
He adds that while the higher inflation and interest rate narrative is taking shape, there is a credible scenario in which deflationary pressures retain their grip on the global economy for some time.
“Various structural factors are unlikely to dissipate in the medium term, including a high stock of global debt (for which even a small rise in rates will create problems), demographic trends and innovation. In my view, therefore, protection from uncertainty via a collection of good, diversified businesses is more important than a big binary bet on either the inflation or deflation narrative.
“As it stands, 2017 is likely to be a similar year with a difficult dividend environment being offset somewhat by the weak pound. The outlook for oil and commodity prices will also be important for the UK index given how important these companies are as a percentage of overall UK distributions,” he says.