Markets stuck in a rut
OFFSHORE fund managers are currently holding the highest percentage of cash in their portfolios since just after the September 11th 2001 terrorist attacks, according to a note by Bank of America Merrill Lynch.
With stock markets around the globe seemingly stuck in a rut, not moving in any direction and even remarkably low in volatility of late, there are some signs that bearishness and pessimism is at high levels
However, Duggan Matthews, Head of Investments (South Africa) at Marriott Asset Management believes there are still good investment opportunities. “It is evident that the opportunity for capital growth lies with increasing global consumerism, as emerging economies consume more.”
Certainly, there is plenty to be gloomy about: global equity markets have been volatile since the beginning of the year. The S&P 500 got off to its worst start in financial history, down approximately nine per cent within the first three weeks of the year.
“Fortunately, markets have since recovered but they remain volatile, especially in the wake of the UK’s Brexit decision. Investors in major multinationals offering consumer necessities have, however, had a very different experience,” says Matthews.
He notes that over the last 12 months, the share prices of companies like Colgate Palmolive and Johnson & Johnson have risen by over 20 per cent.
“In Marriott’s view, businesses of this nature will continue to produce among the best returns with the least risk in the future.”
He suggests the investment landscape over the next decade is likely to be shaped by global consumerism as the emerging middle class continues to grow. Described by global research firm McKinsey & Company as “the biggest growth opportunity in the history of capitalism”, it is estimated that by 2025 annual consumption in emerging markets will increase by $18 trillion and account for half of the world’s consumption.
“Multinational consumer facing companies listed on first world exchanges, such as L’Oreal, Unilever, Coca Cola and Procter & Gamble to name but a few, are likely to be major beneficiaries of this consumption boom.”
In addition to a robust dividend growth outlook, these consumer facing companies have dividend yields in the region of three per cent. This offers investors an excellent entry point into world-class businesses with great long term fundamentals.
“In our view, the risk of investments in these consumer facing multinational businesses not producing good longer term returns is low. This is for a number of reasons,” says Matthew. He lists them:
“Marriott’s chosen multinationals are independent of their home economies. Companies we invest in earn their revenues from across the globe. Consequently, their prospects are not tied to the fortunes of one particular country. This explains why Brexit has had no material impact on the Marriott portfolios and is unlikely to affect their long-term performance.
“Marriott’s chosen multinationals have long track records in emerging markets. According to the June 2005 issue of the Harvard Business Review, successful companies are ones that develop strategies for doing business in emerging markets. These are different from those they use in their home market and those companies that fail to differentiate their strategies often fail to produce good returns.
“Marriott’s chosen multinationals have proven themselves in emerging markets. About 40 per cent of their revenue already comes from these markets. Experience has allowed these businesses to tailor their offering on a country by country basis, ensuring they are well positioned for the expected growth,” says Matthews.
“Marriott’s chosen multinationals are unlikely to be disrupted by technology.
Fifty years ago, the average company lifespan on the S&P 500 was 60 years: today it is less than 20. Since 2002, Google, Amazon, and Netflix have joined the S&P 500, while Kodak, The New York Times and Palm have all fallen off, essentially due to changing technology. Blockbuster, Motorola and Sony are other examples of major companies whose business models have been damaged by technology, resulting in disappointing returns.”
With the increasing pace of technology, the threat of disruption warrants careful consideration. “However, technology does not pose a meaningful risk to Marriott’s chosen multinational businesses, as we only invest in companies which provide day to day necessities, such as Unilever, Johnson & Johnson and Nestlé. Investors can be confident that these companies will still be around in 20 years’ time, even in a world where technology is disrupting many other industries.”
Marriott’s portfolio provides inflation hedged dividend growth. Inflation erodes investment returns and is a major risk to investments that do not provide growing income or dividend streams such as bonds.
However, inflation does not materially threaten the returns of Marriott’s multinationals, as their dividends are inflation hedged. This is because inflation is largely driven by the increasing prices of the consumer items they sell.
“Although bonds are considered one of the lowest risk investments, currently one can receive better yields from multinational companies which offer such inflation protection.
“This is why we consider multinationals to be less risky than bond investments,” says Matthews.
For the broader market, investors remain cautious. In its latest weekly report dated 25 October, STANLIB comments that according to the Bank of America Merrill Lynch note, that offshore fund managers are holding cash, on average, equal to 5.8 per cent of portfolios, up from 5.5 per cent in September and even higher than the peak of 2008 crisis.
Director of Retail Investing at STANLIB, Paul Hansen, explains that this usually presages a fairly good bounce in markets, “because it implies that nervous or bearish investors have already sold equities and raised cash”.
Most fund managers in South Africa are also underweight in equities and overweight in cash. The JSE ALSI is stuck in a trading range dating back to June 2014.
“It is interesting that, despite the pressures on our Finance Minister, both political and regarding his job of managing our finances ahead of his mini budget speech, our rand is threatening to strengthen below 17 to the pound for the first time since December 2013,” says Hansen.
Foreign investors have not been deterred. Hansen notes that the R186 government bond yield is trading around 8.77 per cent, while foreign ownership of the Top 40 shares on the JSE is up in September to 28.6 per cent from 28 per cent in June.
The Mid-Cap foreign ownership is at 31.1 per cent from 34 per cent in June. The Top 40 foreign ownership has climbed from 24 per cent in January 2014 to 28.6 per cent now.
US Market Analyst, Elaine Garzarelli, notes that the US dollar is continuing on an uptrend, which has a negative impact on US company profits, commodity prices and US exports.
However, she expects the dollar to decline after 2017 as global economies grow and their interest rates rise.
The STANLIB report quotes Garza as saying: “Although the Fed has expressed discomfort with the strength of the dollar, it is unlikely to have a big impact on December’s rate hike odds, which are still above 65 per cent.
“Despite static stock markets, Garza’s quants model reading rose from 77 per cent to 81 per cent last week, due to the upgrade of her bullish sentiment indicator.
“Although economic growth is mild, yields and recession risk are likely to stay low, making shares an attractive investment on a relative basis.”
She notes that fair value for the S&P 500 Index is at 2,324, some nine per cent higher than the current level.