Finding value in American growth – expensive but well set?
Co-Head of Equities – EMEA and Asia Pacific at Janus Henderson Investors
Last year saw global growth accelerate at its fastest pace since the financial crisis as this long-running bull market defied expectations and found another gear.
It was a period of synchronised global growth reminiscent of yesteryear – a brief boon for global stock market investors. But with growth inevitably cooling in 2018, the challenge now is to assess where the momentum is strongest and which firms are going to thrive.
With a mandate to invest globally, The Bankers Investment Trust enjoys the privilege of buying stocks without limitations regarding market cap or geography. It is an enviable position, but it also requires a broad depth of expertise across regional markets.
My job is to tie together the knowledge of seven stock pickers, each with deep regional expertise, and guide the overall weighting and direction of the portfolio. Right now, we think the US economy is on a strong footing to outperform other markets in the short- to medium-term, but we think valuations are expensive.
‘the US economy is on a strong footing to outperform other markets’
Given these expensive valuations, we are underweight US (27%) relative to our benchmark (51%) – the FTSE All-World Index. The Trust might be underweight US, but North America still makes up the largest geographical exposure in the portfolio, followed closely by the UK (25.4%).
Therefore, we are taking a very selective approach to the US in order to capitalise on a number of macro-level drivers that we think make the US an interesting market.
Perhaps the most eye-catching event for global investors was the approval of President Donald Trump’s tax reforms towards the end of 2017, which was the first major legislative triumph for the outspoken president. It was also the country’s biggest tax system overhaul in 30 years. We expect his corporate tax reductions to spur on wage growth and fuel a pick-up in consumer spending during the next 12 months.
Talk of a trade war with China might spook some investors, but I’m on the fence. I don’t think a trade war between the world’s two largest economies benefits either country and looks more like a push to force the Chinese to open their economy.
‘aim is to create a portfolio of undervalued companies which enjoy a sustainable competitive advantage’
Whether or not a ‘trade war’ does develop, there are some things that we are confident will keep the US on track, such as the strong domestic economy and a clear pickup in capital expenditure. This growth may be dampened by further US interest rate rises but I expect the Fed to stay behind the curve by limiting the number of interest rate rises this year.
Another positive for the US is the recent revival of the dollar. Since the lows of 2012, the trade-weighted dollar (against a basket of currencies) has appreciated by almost 40%, albeit in 2017 it weakened against most currencies.
There are longer-term concerns about the country’s national deficit rising, but it’s not something to worry too much about now and as growth picks up around the world the deficit could naturally decline.
A hold forever approach
Broadly speaking, the valuation of the US stock market appears elevated on most measures relative to its history. Our North American team remain very conscious of this and continue to abide by a strict valuation discipline.
Although they operate with a “hold forever” mind-set, meaning each company is bought with a view to owning into perpetuity, each holding must demonstrate sufficient upside over the next five years to earn a place in the North American portfolio.
The aim is to create a portfolio of undervalued companies which enjoy a sustainable competitive advantage and operate in structurally growing end markets.
The majority of the portfolio is tied to the following five long-term secular trends, which the team believe to be underappreciated by the wider market; the transformational effect of the internet, healthcare innovation, paperless payments, energy efficiency and emerging market growth.
Take healthcare innovation, which is important given the America’s ageing demographic – the country’s population aged 65-and-over reached 50 million for the first time in 2016 and is expected to continue growing as the ‘baby boomers’ reach retirement.
Considering this, we look for companies that aim to provide solutions to the challenges brought on by an ageing population. For example, California-based contact lens manufacturer The Cooper Companies is a stock we like because one of its revenue drivers stems from the growth in multifocal lenses, which are widely amenable to an ageing population.
Given the relative expensiveness of US equities, we have sold more than we have bought in recent months. The additions we have made to the portfolio come from a diverse range of sectors but importantly all share a common feature: a sustainable competitive advantage, which allows for reinvestment at a high rate of return. Some of our recent additions include luxury cosmetics manufacturer Estee Lauder, computer gaming company Electronic Arts, freight hauling railroad Union Pacific and software giant Microsoft, which is a rarity in the tech sector for its 2% dividend.
Emerging market proxies
Our North American exposure is well diversified across sectors with technology (c. 24%) and financials (c. 21%) afforded the largest allocations.
That said, the financials exposure is potentially misleading as most of us think of banks and insurers when we say financials, but much of our exposure to the financial sector consists of electronic payment institutions like MasterCard and American Express, and conglomerates like Warren Buffett’s Berkshire Hathaway, for example.
‘we look for companies that aim to provide solutions to the challenges brought on by an ageing population’
These companies are positively involved in the long-term socioeconomic trends, particularly the transition to paperless payments.
The trends we refer to are not specific to the US or North America, but the region is typically at the forefront of innovation – perhaps only rivalled now by Asia’s growing technology sector. One of the key trends that guide our stock selection is emerging market growth.
This is most easily demonstrated in the chart below, which shows that although North American stocks account for the largest geographical weighting (27.7%), the companies in the portfolio generate most of their revenues from emerging markets (30.9%).
We could invest directly in to emerging markets – and we do, albeit with only 2.4% of the portfolio – but I like to invest in companies listed in developed markets because they typically have higher quality accounting, audits, governance and lower leverage on the balance sheet. We look for firms in developed markets that have strong business operations in emerging markets, where consumer spending is expanding at a rate only possible with a growing middle class.
The Bankers portfolio will continue to look globally for quality companies with strong drivers in place for future earnings growth but will continue to maintain a strict discipline in terms of the share prices we are willing to pay.
Bull market: A financial market in which the prices of securities are rising, especially over a long time; the opposite of a bear market.
Underweight: To hold a lower weighting of an individual security, asset class, sector, or geographical region than a portfolio’s benchmark.
Secular trends: An economy or market trend associated with some characteristic or phenomenon that is not cyclical or seasonal but exists over a relatively long period.
Emerging market proxies: Securities that derive performance from emerging markets.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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