safety first’ mentality continues to drive corporate management, says Psigma’s Tim Gregory

Tim Gregory, head of Global Equities at Psigma Investment Management, says that investors may benefit from the focus on paying off debt that has been the target of companies around the world in recent years.

Roughly 20% of the S&P 500 earnings have now been reported and as has been customary in recent years the vast majority of companies are beating expectations.

Back in 2009 when the world fell into the “great recession” at the trough of the global financial crisis, many companies prepared their business for the possibility of not just a deep recession, but also a prolonged depression. Four years later, it strikes me that management attitudes are still deeply locked into a “safety first” mode that continues to restrain capital spending projects. This should not be a surprise to anyone given the continual apparent determination of politicians to take us to the brink of disaster before doing what is necessary to keep the global economy ticking over, albeit at a very subdued rate.

Whilst earnings regularly beat, the picture for sales growth is less rosy. I cannot recall the number of times I have written “earnings beat, revenue miss” in my daily notes, but this has been a constant theme in recent quarters. In the aftermath of the financial crisis many smart economic scribes wrote that the “new normal” would be low growth for which there would be no quick fix whatever the central banks threw at the situation. That prediction seems to be truer than ever today as recent economic data has been at best soggy and reporting companies talk of a very sluggish environment particularly in manufacturing.

By focusing on a high level of capital discipline company management has been able to drive high margins that have been sustained despite a lack of top line growth and against all the expectations of the more pessimistic market commentators. Corporate debt has been massively reduced and now shareholders are starting to reap the rewards of this more disciplined environment.

Apple revealed its first quarterly profit drop in ten years earlier this week, but it was able to appease shareholders with a 15% rise in the ordinary dividend and a plan to buyback $100bn of shares through 2015. As a result the stock price reaction yesterday divided investors between those who still want to invest in Apple for its innovation and growth prospects and those investors for whom the search for income has become more difficult and some would say more dangerous, as yields on sovereign bonds and high yield credit shrink to ever less appealing levels. Of course being an equities bloke I am always biased, but I would rather buy a stock yielding 3% and growing its dividend, with a ton of cash in its balance sheet; than invest in Japanese government bonds yielding 0.57% with debt of over 200% of GDP and a central bank who have informed us that planned inflation will hopefully reach 2% in the future.

Talking of Japan, after such a power packed run company results need to match the new expectations created from the benefit of a material devaluation of the yen. Mitsubishi Motors shares soared 20% yesterday when the car manufacturer announced that profits would be way ahead of expectations. Canon on the other hand raised guidance, but was unable to meet the market’s already upgraded expectations and the shares fell 7%. However, the additional factor that is very supportive for Japanese stocks is also the strength of company balance sheets that have been accumulating cash and paying off debt through the long dark days of deflation and an ever appreciating yen.

Psigma’s view of the world is that equities remain our favoured asset class for the foreseeable future. This is not because we suddenly see a new era of global economic growth, but more because we expect the environment to remain challenging and hindered by constant political dithering. In that environment we expect companies to continue to grow their earnings at a rate that will continue to encourage dividend growth, share buybacks and debt repayment, which are all supportive of long-term equity market valuations.


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