Global economies are stuck in a rut, constrained by demographics, high government debt, cautious households, low productivity growth and excess capacity. Inflation remains low, real interest rates hover at zero and GDP growth is slower than expected or desired. On the other hand, there is no indication of a recession as long as financial liquidity remains at a comfortable position.
What can equity markets offer under these conditions and what are the most likely type of stocks and funds to hold? The first observation is that this is when an active portfolio should pay off. The pockets of attractive investment options have to be captured and the portfolio may need to rotate as some sectors or regions are better value.
A low-growth world means bunkering down in "safe" stocks such as consumer staples, healthcare, REITs and IT – all apparently easy options.
But not so fast – in the staples sector globally, food retail has done poorly compared to consumer product groups, partly due to their exposure to emerging economies.
In health, pharma and biotech have been well outstripped by healthcare equipment and services this year to date. Even in the low-growth world defensive portfolio, a stock bias can make a big difference.
Another approach is to turn the defensive market on its head. Many are concerned that the sectors nominated above and the US market on aggregate are overpriced relative to prospective earnings growth. There are a multiple of ways to consider doing something different.
Those who were willing to move into emerging markets have been well rewarded. Brazil, Indonesia and Hungary produced double-digit returns year to date after being out of favour for some time. Japan is the second-best performing region from an Australian investor's perspective over a two-year period, though recent returns have lagged. Of course, buying into these sectors should not just be based on the markets having been beaten up, but requires confidence that the profit cycle is improving.
Productive territory
Sectors that have been undermined by events or trends can also be productive territory. Energy is clawing its way back into positive performance. Not only has the commodity price recovered from its sharp fall, but many companies have dealt with their operating costs. Once again, some global funds have chosen to take a position in the sector. Lower risk is an energy service provider; those willing to take higher risk go to the leveraged producer.
Financials are in the same bucket, awaiting a signal. Global banks can trade well below their book value for good reason, but some get caught in a negative wash even when their structure is perfectly solid. Judging valuation of banks in today's world is tough, as the past is unlikely to be a good indicator. Capital requirements, regulation and growth are vastly different. Yet the specialist in the sector may be able to identify a number of banking organisations which are oversold.
In short, the adage of buying when terrified can pay off, allowing for judgment and recognition of risk. The faint-hearted have sat in cash and watched a world of good returns in almost all asset classes pass them by.
There are, however, other scenarios that are lingering in the realm of the possible. A modest uptick in inflation is not priced into equities. Some may benefit, while others will find profit growth challenging or be marked down from a reversal in the bond proxy trade (aka yield stocks). The Fed could move faster than the market is assuming, China could hit another speed wobble and, of course, politics is more than likely to play a role. The question, really, is how big.
Giselle Roux is chief investment officer of Escala Partners.
