Great companies can navigate economic ups and downs
Great companies can navigate economic ups and downs
Sticking with industry-leading companies able to adapt to change is more important than attempting to predict the next twists and turns of the economy, argue Jupiter’s Mark Heslop and Mark Nichols.
The year 2020 has highlighted the risks of putting too much faith in economic projections or market expectations. We choose not to spend our time trying to forecast economic activity or index valuations. Instead we focus on companies, on business models and on long-term trends and growth opportunities. Ultimately, great companies can navigate economic cycles (both the ups and downs) better than poorly managed or undifferentiated businesses. Whatever our personal opinion about the broad economic outlook for the year ahead, it does not change our conviction about the best businesses to own for the long term.
We think the three big questions facing investors over coming months are likely to be:
We think the three big questions facing investors over coming months are likely to be:
1. How will the world change post lockdown?
Many – indeed, most – activities will be much the same post lockdown as they were before Covid-19. People will go back to their offices, return to restaurants and bars, and travel overseas on holiday. But people and businesses have learnt a lot about themselves during the past 12 months. Some of us can work effectively (and cost efficiently) from home; buying goods and services online is easier than going to the stores; and we can move freely without physical cash in our wallets. These trends, among others, were happening anyway, but they have been accelerated by the crisis, and they will increase the pressure on companies to stay ahead of the curve. The key, we believe, is to stick with industry leaders that are best positioned to adapt to these changes and capture the opportunities.
The greater impact is likely to come from government responses to the crisis. Unemployment and a massive build-up of debt are likely to be two enduring legacies of 2020. We expect this to result in a multi-year extension of enhanced monetary stimulus (cheap money) and massive infrastructure investment, specifically directed towards the green economy. Corporates may well be expected to help balance the books, especially unpopular ‘polluters’ and the much-politicised consumer tech companies.
The greater impact is likely to come from government responses to the crisis. Unemployment and a massive build-up of debt are likely to be two enduring legacies of 2020. We expect this to result in a multi-year extension of enhanced monetary stimulus (cheap money) and massive infrastructure investment, specifically directed towards the green economy. Corporates may well be expected to help balance the books, especially unpopular ‘polluters’ and the much-politicised consumer tech companies.
2. Will Value or Growth outperform? What will happen to interest rates?
The first of these questions – Value or Growth? – is widely debated by investors at the moment, but we think it is somewhat meaningless. Value (companies whose share prices seem relatively cheaper), and Growth (companies whose revenues are growing relatively faster) are not necessarily mutually exclusive. We like companies whose long-term cash generation potential is being underappreciated and therefore undervalued by the market. We also like companies that have opportunities to grow, because they have the greatest potential to compound shareholder value. The Value versus Growth debate is usually centred around the price earnings ratio (P/E) of a company and how it compares to its historic average. We strongly believe that P/E is a flawed valuation metric1 because it fails to account for companies’ differing growth prospects, their capital intensity, or any changes in the risk-free rate2.
The more important question is whether interest rates will rise and what will be the implications if they do? We make no predictions but offer the following observations.
The more important question is whether interest rates will rise and what will be the implications if they do? We make no predictions but offer the following observations.
- Rising unemployment and excess capacity in global economies are likely to limit the effectiveness of central banks’ ability to reinvigorate inflation.
- The cost of debt will need to be kept low if governments are going to be able to service their rapidly growing debt piles.
- A rising rate environment likely indicates better economic activity and inflation, and while this may be good for broad corporate pricing, undifferentiated products will continue to be forced to compete on price and will struggle to deliver attractive margins. Disruptive forces will continue to disrupt, and zombie businesses will potentially be allowed to die.
A rising interest rate environment would change the relative attractions of the individual companies that we want to own, but it would not change the pool of companies that we want to own.
3. De-globalisation and Brexit?
Fragmentation of the global economy is, in our opinion, a net negative for aggregate human prosperity. It will create inefficiencies in supply chains, duplication of capacity, and an inefficient allocation of capital. Geopolitical concerns about the rising power and influence of China and the long-term viability of the European project will continue to influence the political agenda, and could give rise to further protectionist policy. But we do not expect a complete dismantlement of global trade.
Although the majority of the companies we invest in sell their products and services outside their home turf, we expect most to be relatively protected from near term political interference. Most importantly, we believe that these companies’ products are differentiated and highly valued by their customers. In addition, international revenues are to a large extent generated or manufactured domestically. In the cases where supply chains need to be brought increasingly onshore, we think it best to be aligned with companies that have the pricing power to pass on any subsequent cost inflation.
Although the majority of the companies we invest in sell their products and services outside their home turf, we expect most to be relatively protected from near term political interference. Most importantly, we believe that these companies’ products are differentiated and highly valued by their customers. In addition, international revenues are to a large extent generated or manufactured domestically. In the cases where supply chains need to be brought increasingly onshore, we think it best to be aligned with companies that have the pricing power to pass on any subsequent cost inflation.
1 Especially when P/E is the sole valuation metric being considered. P/Es might prove a helpful indicator of the market’s change in near term expectations but are a poor guide to long term investment opportunity.
2 The yield of any investment has to be compared with the yield available from an investment of no or negligible risk, for which the 10 year government bond yield is commonly used. If the yield goes up, so should the expected return on riskier assets i.e. the P/E should fall. The same is true in reverse.
2 The yield of any investment has to be compared with the yield available from an investment of no or negligible risk, for which the 10 year government bond yield is commonly used. If the yield goes up, so should the expected return on riskier assets i.e. the P/E should fall. The same is true in reverse.
Please note
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
Important information
This document is for informational purposes only and is not investment advice. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. Issued by Jupiter Asset Management Limited which is authorised and regulated by the Financial Conduct Authority, registered address is The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission. No part of this content may be reproduced in any manner without the prior permission of Jupiter Asset Management Limited.