Investing for slower growth
With the US stock market averages hitting new highs, selectivity will likely be the key to successful investing in the months and years ahead. Some trends will persist but others may fade as the extended economic recovery approaches record duration.
For one thing, investors should prepare for slower growth going forward. A recent report from the International Monetary Fund forecast world gross domestic product growth will decelerate to 3.5 per cent this year from 3.7 per cent in 2018. Longer term, the rate of forward progress will probably be much lower.
Impediments to growth in today’s world are rising protectionism, increasing trade tensions, a decline in business confidence and questions about what the Fed and ECB will do with their stretched balance sheets and the large and growing budget deficits across the developed world.
According to another report published by Organisation for Economic Co-operation and Development, US growth is forecast is to decelerate to 2.6 per cent growth in 2019 and 2.2 per cent in 2020, down from the last year’s rate of 2.9 per cent. However, a US recession is not expected.
Meanwhile, Europe is struggling with a moribund economy. Italy is in recession and Germany is very close to having one officially. European equity markets have dramatically lagged the US over the past few years and interest rates in the euro currency are still negative for most short duration bonds.
The European Parliamentary Research Service recently published a long-ranging report on global output which listed the following megatrends:
• A richer and older human race.
• A more vulnerable process of globalisation, with uncertain leadership.
• A transformative industrial and technological revolution.
• A growing nexus of climate change, energy and competition for resources.
• Changing power, interdependence and fragile multilateralism.
Economic growth is simply the product of a country’s work force growth and the productivity of those workers. Financial leverage has also played a part in temporarily magnifying corporate profits and GDP in many regions. However, leverage has its limits and usually ends with a need to deleverage.
Deleveraging acts as a headwind. For example, Japan, whose total debt-to-GDP ratio stands at an elevated level of over 200 per cent is expected to grow at just 1 per cent in 2019 and a mere 0.5 per cent in 2020, according to the IMF report. Japan’s debt-laden economy, also restrained by a shrinking population has struggled for decades.
Meanwhile, labour force participation, which had been increasing over the past few decades, is expected to decline in the years ahead. Already, many European nations are experiencing the double whammy of lower birth rates (less future workers) and people living longer (less productive citizens.) This means fewer workers will need to support more older people who are no longer producing.
Summing up the case for slower secular growth are my four “D’s”: demographics, debt, deglobalisation and divisive politics. Examples of the latter include America’s increasingly polarised politics, rising fragmentation within the European Union and the ongoing turmoil of the Brexit negotiations.
Productivity and business investment are clearly being hampered by trade wars, tariffs and overall policy uncertainty.
As Christine Lagarde, the IMF chairwoman, recently explained, businesses do not know what will happen with tariffs and in particular how much, where and for how long. Lack of certainty on key issues keeps business investment on the sidelines as trade tensions remain unresolved and protectionism becomes the norm.
When the global economy is expanding and monetary policy is accommodative, investing in the broader equity markets and more cyclical sectors can be a profitable strategy. A rising tide lifts all boats as the saying goes. However, profiting from an outgoing tide requires selectivity.
Over the past decade, investing in so-called “growth stocks”, either individually, or through mutual funds has been the winning strategy. A basket of growth stocks as measured by the Russell 1000 Growth Index has outperformed its opposite, the Russell Value Index by about 40 per cent over the past ten years. Value stocks could play catch up in the near term, but investors should still have some exposure to a growth strategy.
Faster growing companies are typically exploiting niches, taking share from established players through disruptive technology or creating new markets. These entities are not as dependent upon overall economic growth for success because they are creating their own momentum.
Growths stocks which keep up the pace should continue to be more richly rewarded in a lower-growth world.
One industry we find compelling at current levels is healthcare. After a recent price decline, stocks in this sector are trading at fire sale prices while possessing attributes of both growth and value. Healthcare as a group has underperformed the S&P 500 by a whopping 13 per cent over the past 90 days.
Based on an historical analysis of rolling returns, the recent underperformance represents a two standard deviation event, or one which can be expected to occur just once every ten years. A reversion to the mean is in order and, importantly, demographics actually favour the healthcare sector as people living longer can be expected to spend a larger amount on these services.
Fixed-income investors can also benefit from a return back to the “new normal”. Slower growth means the Federal Reserve is less likely to tap the monetary breaks and send interest rates higher. Investors can be more confident in longer-duration fixed income securities. But once again, selectivity is critical.
• Bryan Dooley, CFA is the senior portfolio manager and general manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority
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