Short term ‘wobble’ possible, but corporate profitability continues to improve, says OMGI’s Richard Buxton
Richard Buxton, head of UK Equities at Old Mutual Global Investors, says there may be a brief market ‘wobble’ over the coming quarter, but that the trend of improving corporate profitability continues.
As we look at the UK and global economies, it quickly becomes clear that there is much to be optimistic about. Indeed, such optimism would seem to be backed up by the performance of equity markets which, in the absence of anything to depress them, quickly give the impression that their natural tendency is to trend upwards. This is not to say, however, that the risks and volatility have disappeared for good, or that it will be plain sailing from here. But by seeking to better understand a small number of short-term concerns, investors may be able to equip themselves with the knowledge to help navigate the months and years ahead. As we see it, these concerns include:
• tapering (the gradual removal of monetary stimulus) by the US Federal Reserve (Fed) and the pace of higher bond yields;
• US earnings estimates that are too high, leading to an increased likelihood of downgrades;
• volatility of macro-economic data, leading to the possibility of a growth scare, especially if investors are spooked by a few weaker-than-expected sets of company results or data releases;
• the resurfacing of Eurozone tensions; and
• Chinese GDP growth consensus being revised down to 7% – although the latest indications are that it is unlikely to be any lower than that.
Past performance demonstrates that there is every chance that one or more of these concerns could once again lead to the now ‘traditional’ September/October equity market ‘wobble’. However, beyond these concerns, we have two particular worries. The first is the likely impact of US Fed stimulus tapering on emerging market economies, given the body of evidence to show that a narrowing in the US current account deficit in not always good news for emerging markets.
The second worry surrounds the widespread practice in emerging markets of government subsidy of fuel prices. We don’t believe that this is sustainable in the longer term, especially with higher oil prices; the effect of the withdrawal of such subsidies on both growth and political stability remains a significant unknown.
More generally, the excess supply in the global economy is plain for all to see; the fact of the matter is that the world has some way to go before it has fully recovered from the global financial crisis. Even though central banks are expected to begin removing some of the additional liquidity they have pumped into the financial system in recent years, they will nevertheless remain highly supportive of the global economy. Against this backdrop, in our view, as long as bond yields drift up in a very gradual manner – as a consequence of improved economic data – equity markets should continue to be able to make sustainable gains.
We have long believed that the UK economy would see tangible signs of improvement this year and next; this should be a function not only of improved consumer sentiment, but also of a pick-up in the manufacturing sector, and in investment. Elsewhere, all-important employment figures have seen relatively consistent gradual growth in recent years, notwithstanding the blip in 2011 when public sector redundancies more than offset private sector hiring.
This relatively rosy picture is not, however, borne out by GDP figures. Nevertheless, investors may be well advised to question the accuracy and validity of GDP data published by the Office for National Statistics, given that these have almost invariably been subject to subsequent revision. This no doubt reflects the fact that it is notoriously difficult accurately to measure GDP.
By contrast, employment statistics are somewhat easier to calculate. Both the total level of employment and the average hours worked have been trending up for some time now, while GDP growth has struggled to keep pace. In our view, it is unlikely that GDP growth would lag improvements in employment data to quite this extent.