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Diary of a fund manager - Broad Canvas - 29.04.19

David Miller, Investment Director, Quilter Cheviot

This week’s Diary is about breadth and depth. The quarterly results season is in full swing and patterns of success and failure are emerging. Also, some thoughts on how markets go about setting the price of the securities that we invest in.

Softly, softly, equity markets continued to move higher. Bonds, gold and the dollar also had a reasonable four day week. Pragmatic economists are now raising their growth forecasts, whereas the pessimists remain focussed on any number of negative indicators. Having set aside fears of imminent recession or an inflationary boom, the next test of investor confidence will be the planned stock market listing of Uber, one of the mega-disruptors. The indication is that it will be valued in the high tens of billions despite never having made a profit. Yet another beneficiary of ten years of ample liquidity and low interest rates in a way unimagined by the architects of Quantitative Easing.

Those who focus only on economics, index tracking and sentiment may now be getting ready for the distractions of the summer season. Those of us who select companies operate on a broader canvas have much more to consider. Regular as clockwork, the quarterly results season is in full swing and the details paint a diverse picture of the present. Drawn from a report by JP Morgan, over a third of US companies have already announced their numbers, 26% in Europe and 16% in Japan. The good news is that in the US, 77% are ahead of expectations and that earnings per share growth is 5%. For Europe the numbers are 48% and 4% and in Japan 42% and 5%. Then again companies are masters of expectation management and guide analysts to lower numbers that they can then beat. The games we play. In absolute terms, the issue is whether earnings growth of 4-5% is good enough? Bearing in mind that we remain in a low growth world with zero interest rates seemingly for years to come, the answer is not great but every little helps. Encouragingly, a number of companies have been able to increase sales and not just rely on cost cutting.

Delving further below the surface is even more revealing. The good and the bad seem to fall into four main categories;

  • However strong the brand and smart the management team, sectors suffering from structural change like retail or automotive are hard places to grow. Cheap and getting cheaper is the message.
  • Industrial companies that are closely linked to economic growth are struggling to increase revenue. Global trade does seem to be slowing and, a massive generalisation I know, we are buying less stuff and more experiences than in the past.
  • Despite bad publicity, the technology companies remain in their pomp. Amazon, Facebook, Microsoft to name the largest continue to grow at mid-teens or higher rates. Also, as they reinvest cash flow some of their new small subsidiaries are delivering revenue growth of 50% and more.
  • The final category covers the rest. Whether pharmaceuticals, consumer staples, high fashion or financials, some companies are doing well and others not. Generalisations are of little use; it’s a matter of product or service, management skill and valuation. This is where the stock analysts really come into their own. We expect them to be on top of all of this, be right and communicate any issues with minutes of results being announced. I know that our team has been burning the candle at both ends in the last couple of weeks for which we are suitably grateful.

Stepping away from the day to day detail is also important. Whilst reading about the ethics of social impact bonds I was stuck by the challenge of setting the right price. At heart SIBS are a contract between the public sector and investors and so measuring the results and agreeing the return are absolutely critical. All I will say is that it’s complicated, but the similarities with utility regulation, pricing structured products and more generally how financial markets operate are clear. In markets there are price setters and price takers. Those who set the price tend to be large and have access to a lot of capital. Even if they are wrong they can afford to be patient. As Keynes said, ‘the market can remain irrational a lot longer than you and I can remain solvent’.

Major markets are too large for anyone to control, but illiquid specialist instruments are where the issue of price setter/price taker tends to arise. Investors are almost always price takers which is where analysis and judgement comes in. Recognising this asymmetry of power is critical to success. I am not a poker player but this quote encapsulates the issue; ‘if you have been in the game 30 minutes and don’t know who the patsy is, you’re the patsy’.

Markets are an efficient way of pricing risk and reward, they get to the right answer pretty quickly and are almost always liquid, but it will always be a case of buyer beware.

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