By Clyde Rossouw
At a glance
- Investors are becoming increasingly nervous about the outlook for returns
- Structural, rather than cyclical, growth will be key
- Valuations appear high, but quality stocks don’t look overly stretched
- Prudent stock selection will be required to separate the winners from the losers in 2018
Growth strengthening, but risks remain
As ‘the most hated bull market in history’ approaches its tenth year, with the S&P 500 having delivered over 350% total cumulative returns since its post-crisis lows, investors are becoming increasingly nervous about the outlook for returns and dividends.
Global growth appears to be strengthening and becoming more synchronised, and the first tentative steps towards monetary policy ‘normalisation’ have been taken in the US and the UK. However, the outlook remains far from certain. There are a number of risks that could derail this fragile global recovery, ranging from fiscal and monetary policy error to escalating geopolitical tensions, protectionism and ever-increasing debt levels.
Structural growth will be key
Against this uncertain backdrop, and as we look forward to 2018, we believe a focus on structural rather than cyclical growth will be key.
One cannot rely solely on the fortunes of exogenous factors such as commodity prices, interest rates, or the economy to sustain growth. As has been the case in 2017, particularly in the technology sector, we expect the market to again reward quality companies that prove their ability to deliver sustainable growth in earnings and cashflows, and punish companies across the market whose earnings disappoint.
Figure 1: High quality profits (FCF conversion)
Source: Investec Asset Management and FactSet, as at 30.09.17. Investec Global Franchise Strategy re-weighted excluding cash and equivalents, since inception
Figure 2: Sustainability high profitability (ROIC)
Source: Investec Asset Management and FactSet, as at 30.09.17. Investec Global Franchise Strategy re-weighted excluding cash and equivalents, since inception.
We are mindful of the threats that also exist to the future growth of Quality companies. For example in consumer staples disruption from the ‘infinite shelf’ of e-commerce, is lowering barriers to entry and supporting smaller brand and private label penetration, thereby increasing fragmentation across categories. However, the impact of this and other trends will not be felt evenly across companies. In many cases it will likely provide opportunities as well as risks. Careful stock selection will be required.
Valuations not overly stretched
Equity markets have re-rated significantly since the Global Financial Crisis and are no longer cheap. In the context of a low-growth, low-return world, however, we do not believe that the valuations of quality stocks are overly stretched. Relative to longer-term history, we believe the valuations of quality stocks remain attractive, given the quality and growth characteristics one is paying for and the valuations of bonds and other assets. Again, however, stock selection will be key.
In 2017, investors have been rewarded for successfully picking stocks that have delivered growth. However, perhaps more important to investment performance in 2018, will be avoiding the losers rather than picking the winners. This will require careful management of downside risk, including both business and valuation risk. Again, active stock selection will be critical.
Focusing on the ‘quality’ advantage
Overall, while more economically sensitive sectors with global exposure, such as energy and mining, have rallied recently, the sustainability of this rally is uncertain. We believe that carefully selected quality companies, with long-term structural rather than short-term cyclical growth drivers, should be well placed to perform well in 2018.
We will continue to focus on finding these attractively valued quality companies, with demonstrably enduring competitive advantages that are able to continue to grow their cashflows into 2018 and beyond.
Collective investment schemes (CIS) are traded at ruling prices and can engage in borrowing, up to 10% of portfolio net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the Manager, Investec Fund Managers SA (RF) (Pty) Ltd which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. CISs are generally medium to long-term investments and the manager gives no guarantee with respect to the capital or the return of the Fund. Performance shown is that of the Fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax and past performance is not necessarily a guide to the future. The value of participatory interests (units) may go down as well as up. Performance figures above are based on lump sum investments, using NAV to NAV figures net of fees with gross income reinvested, in South African rands. The value of participatory interests (units) may go down as well as up. Different classes of units apply to the Fund and the information presented is for the most expensive class. Fund valuations and transaction cut-off time are 16h00 SA time each business day. This portfolio may be closed in order to be managed in accordance with the mandate. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. A higher Total Expense Ratio (TER) does not necessarily imply a poor return, nor does a low TER imply a good return. Where portfolios invest in the participatory interests of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Fund prices are published each business day in selected media. Additional information on the Fund may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. Investec Asset Management (Pty) Ltd (Investec) is a member of the Association for Savings and Investment SA (ASISA). The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. All information provided is product related, and is not intended to address the circumstances of any Financial Service Provider’s (FSP) clients. In terms of the Financial Advisory and Intermediary Services Act, FSPs should not provide advice to investors without appropriate risk analysis and after a thorough examination of a particular client’s financial situation. Investec Asset Management (Pty) Limited is an authorised financial services provider.