5 Jan 2016
Jacob de Tusch-Lec – Artemis Global Income Fund
Markets seemed to welcome December’s increase in US interest rates as confirmation that things are getting back to ‘normal’. But it is still early days. We don’t know what effect even a paltry 25 basis points rise in rates might have on liquidity, leverage and thus on appetite for risk. And we can only speculate about when – or even if – the next two or three rate rises will occur. So there is still plenty of uncertainty as to what path the normalisation of monetary policy will follow.
There is, moreover, huge uncertainty about how the global financial system will cope with the draining of liquidity. There may be reasons to believe that a slight rise in borrowing costs – from absurdly low to very low – will prove a non-event. But it is possible that major problems could arise in areas of the global economy that have hitherto been propped up by cheap borrowing. An environment of abundant capital is giving way to capital scarcity. The potential victims of this transition are clear: emerging markets, real estate, geared companies and infrastructure projects that would not have been profitable with borrowing costs at ‘normal’ levels.
So when thinking about any investment opportunity today, it must pass the test of being able to work when rates are higher. Indeed, we have already seen equity markets punishing those that can’t. Although I'm not predicting a collapse, I do find it surprising that the markets are so sanguine about interest rates rising – so prepared to trust the Fed – even as the global economy slows.
In the fund, we began a modest ‘de-risking’ of the portfolio last summer. That continues. Until we have more clarity on the effects of the first rise in US interest rates in a decade, we prefer to hold higher quality stocks (those with more reliable earnings and stronger balance sheets). Clearly, there is value in the most unloved parts of the market (energy, miners and emerging markets). And investors’ underweight stance in these sectors may have created the preconditions for a rally. But the uncertainties are so great that this is not, in my view, the time to take outsize risks. So the fund has little exposure to the cyclical areas of emerging markets. For now, we prefer to stick to European and Asian ‘bond proxies’ and to companies that will benefit from the strength of the US economy.
Simon Edelsten – Artemis Global Select Fund
After six years of a sporadically vigorous recovery, in 2016 markets and economies will need to adjust to higher interest rates in the US. Economic growth seems likely to be slightly less marked. So while those companies who have invested in their own growth should continue to thrive, those dependent on the wider economy could struggle.
Rising interest rates in the US make it likely that the dollar will be strong. In combination with cheap gasoline and rising employment, that could mean consumer spending in the US strengthening over the next couple of years. Meanwhile, with dollars in scarce supply, emerging markets are likely to remain under pressure, particularly commodity exporters such as Brazil, South Africa, Russia and Indonesia.
Elsewhere, interest rates in Europe and Japan should remain low but core inflation is likely to track slightly higher – so it will be hard for rates to fall any further. As it has elsewhere, the application of quantitative easing in Europe seems to have raised property prices and depressed the currency without having much effect on confidence. For its part, the Japanese economy is stable. The best investments in that country will be in companies whose managements are increasing returns to their shareholders by investing efficiently and buying back shares.
Many commentators say we should look beyond the rate-rising cycle, which is already well-known and so ‘in the price’. Markets, however, have rarely proven to be particularly far-sighted; tightening cycles have often proven to be trickier to negotiate than investors initially expected. So caution could be warranted in 2016.
In the Artemis Global Select Fund, we have increased our exposure to ‘growth’ in these investment themes:
Online services: Amazon, Facebook, TripAdvisor
Low carbon world: Electric grid companies plugging in more renewables
Tourism: Beijing Airport, Sydney Airport, Carnival Cruise Lines
Scientific equipment: Thermo Fisher, Agilent
Adrian Frost - Artemis Income Fund
The outlook for UK income faces a number of challenges. A preponderance of the market’s income is derived from companies sensitive to commodity prices and their earnings are under pressure. Realistically, this means some dividend cuts are likely. However, the poor performance of these stocks in recent years and their very high yields suggest dividend cuts have been anticipated – so the downside should be modest.
From the perspective of the Artemis Income Fund, we have substantially reduced our exposure to these vulnerable dividends over the past two years. We have been concentrating on finding more secure long-dated sources of income, albeit sometimes on lower yields than we would like. As a result, the fund’s recent dividend growth has been quite muted. Our objective is that future dividend growth will, in time, make up for this. We were, moreover, right to resist the allure of high yields in commodity-sensitive areas. That has been reflected in returns that have been markedly better than the market.
We see no material change in the economic environment. The best that can be said is that the risks have been well rehearsed. Companies are still finding revenue hard to come by and costs, which hitherto have been well-managed, will increasingly be difficult to contain. For example, for UK companies focused on the domestic economy, the introduction of the ‘national living wage’ will be a significant cost. In the US, meanwhile, strong employment suggests that wage inflation will be more marked.
Our preference is still for companies whose influence over their own prospects is above average and those for whom the challenges are surmountable, rather than structural.
Ed Legget – Artemis UK Growth Fund
As we look into 2016, we are more cautious than we have been for some time. In an environment of slowing global growth, on-going weakness in emerging markets and continued low commodity prices, the consensual forecast for a 5% rebound in UK earnings seems too optimistic. Unlike in 2012 and 2013, an expansion of the multiples at which stocks trade looks unlikely to rescue investors. That is because this time the starting multiple is higher at 16x forecast earnings. Second, global monetary policy looks set to become less, not more, accommodating as the year progresses.
In 2016 commodities will probably prove a key call for investors in the UK market. Our outlook is guarded for the time being. Supply and demand are out of balance and are likely to remain so, capping commodity prices and in turn the share prices of commodity producers. It is an area we will be monitoring closely over the year as there will be money to be made here – but not yet, in our view. Elsewhere, we are becoming more cautious on the prospects of some UK domestically focused stocks. Our reason is that the significant rise in the minimum wage in April looks set to put pressure on profit margins.
On a more positive note, we are optimistic about the outlook for UK financials, in particular life insurance and domestically focused banks. We see scope for both sectors to increase dividend payments – a trait that we believe will become increasingly attractive as dividends in other parts of the market fall.
Given this far-from-bullish outlook, we think there is protection in valuation. We look for companies combining strong cashflows at a modest valuation. The concentrated nature of the fund, combined with our limited ability to short stocks, will continue to provide us with the flexibility to maximise the fund’s exposure to the investment opportunities we identify.
Financial conditions in the US are tighter than they were two years ago. Despite this, we do not see the ingredients for a profits recession. These usually occur when high short-term interest rates choke off economic growth. In this over-indebted world, we should not rule out the possibility that the modest degree of monetary tightening we have seen to date will cause growth to weaken – but we don’t think that is the most likely outcome. Instead, we believe the most likely scenario is for muted growth in the US economy and modest earnings growth in the US market.
Yet while the overall macro picture may look relatively stable there is a lot going on beneath the surface. Growth companies – as epitomised by the so-called ‘FANG’ stocks (Facebook, Amazon, Netflix and Google) – have done very well. Cyclical companies, in contrast, have performed poorly. Typically, when cyclical companies have not performed well they tend to enjoy a period of stronger performance early in the New Year as investors’ time horizons lengthen (having grown short towards the end of the previous calendar year). Commentators tend to frame this debate as being a binary choice between cyclicality and growth. But our view is that – as ever – both earnings growth and valuations will matter
Meanwhile, we expect the debate surrounding ‘disruption' to remain front and centre. So far, it has been the winners from disruption (Amazon, Google, Netflix and the like) who have received the bulk of the attention. But we must imagine that the incumbent companies will react to this competitive threat. Some, like Wal-Mart, will increase their investment in online strategies. We also believe that M&A activity is likely to intensify in some of these disrupted industries.
So where does that leave us? Like last year, we believe 2016 will be a market for stockpickers. In the absence of help from monetary policy, company fundamentals and valuations will be key.
One caveat: there is the possibility that 2016, an election year, sees politically-inspired volatility. But if the Republicans adopt you-know-who as their presidential candidate the market could well assume that Hillary Clinton is a shoo-in to become the 45th US President and that the status quo will therefore persist. It could be an entertaining year.
Mark Page – Artemis European Opportunities Fund
What will happen in 2016? Before venturing an opinion we offer this caveat: we are stockpickers. We have no particular talent for forecasting short-term changes in asset prices. Nor are we experts in economic matters. But we do hold regular meetings with European companies. They are pointing towards weak growth in the world’s emerging economies but with developed markets offering some solace – particularly in Europe. Fiscal austerity is no longer a drag on economic growth, consumers are increasingly confident and lending by banks to the corporate sector has risen for the first time since 2012. Meanwhile, labour costs aren’t rising and input costs are falling. That combination should help margins and so sustain decent growth in both earnings and dividends.
Against those positives, we must set valuations, which are slightly too high for our liking and could act as a small drag on returns. The median stock in Europe (excluding the UK) is valued at 20x earnings, above the long-term average of 15x. (Here we use trailing valuation measures instead of the forward-looking measures preferred by the stockbrokers, whose analysts tend to be too optimistic.) The result is that we expect a total return from European equities in the mid-to-high single-digits. That might not sound thrilling – but given that 10-year OATs (French government bonds) yield less than 1% it is compelling.
James Foster – Artemis Strategic Bond Fund
There is plenty for bond markets to worry about. On the one hand, interest rates in the US are rising. On the other, while the ECB has just lowered rates its enthusiasm for further QE may be waning. The Bank of England, meanwhile, is likely to raise rates – but perhaps not until the autumn. The confusing backdrop this creates is unsettling bond markets.
Corporate bonds should be performing well. Corporate profitability is good which should make servicing debt easier. The concern, however, is that investment-grade companies are being tempted by the generally low interest-rate environment to take on too much debt. This is particularly true in the US where there is evidence of companies using leverage to pay enhanced dividends.
Politics will be a big factor in the year ahead. The impending US election could leave the country in limbo until November. Meanwhile, there was no clear outcome from recent elections in Spain. This, combined with the rise of anti-EU parties across the continent – and a potential referendum on a Brexit – mean there is the potential for some instability in Europe too.
High-yield markets in the US look very weak. The fall in commodity prices is having a wider effect. This may be creating an opportunity; we feel things are beginning to look oversold. There are, meanwhile, plentiful opportunities in the European high-yield market. Elsewhere, we believe our banks and insurance holdings should continue to produce good returns.
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