Mega themes driving equities

By Jayson Forrest

IMAP Specialist Webinar Series Serving HNW June 2023

Megatrends and a rapidly changing world are providing opportunities for astute investors in both international and domestic equities. Monik Kotecha (Insync Funds Management), Hamish Tadgell (SG Hiscock & Company) and Brad Creighton (AMP North) share their views on the key drivers and themes playing out in equities over the next six months.

 

Underpinning the investment approach at Insync Funds Management is the search for businesses with sustainable earnings growth. These types of businesses, says Insync Chief Investment Officer, Monik Kotecha, will typically see the share price follow their earnings growth over time, regardless of market conditions over the short-term.

In providing an update on equities at an IMAP Specialist Webinar Series, Monik says Insync looks for the following two factors when identifying businesses with sustainable growth:

1. High quality businesses that are profitable. The quality of these businesses is measured by the return on investor capital, such as high net/gross margins, little debt, and the ability to generate considerable cash.

2. Businesses need to have a long runway of growth. These runways of growth are typically linked to the business operating within a megatrend.

According to Monik, megatrends are powerful forces that shape demand for goods and services. They also represent enduring tailwinds that push well run companies to success beyond market expectations.

As an example of a megatrend, he points to U.S. multinational technology company, Nvidia, which operates in the artificial intelligence and software space. Nvidia announced US$5 billion in extra revenue coming through its chip business this year.

“That’s an example of real revenue, which caught out many investors. There have been many similar examples of businesses that have continued to deliver very good growth during the volatility of the last couple of years,” he says.

However, Monik emphasises that megatrends do not have to be technology-related. In fact, Insync is currently exposed to 16 megatrends in its global equities portfolio. These megatrends cover the areas of: contactless economy; workplace automation; silver economy; emerging middle classes; streaming; data analytics; video gaming; the internet of things; enterprise digitalisation; pet humanisation; premiumisation; food away from home; household formation; beautification and wellbeing; experiences; and low emission energy.

“These are all secular growth trends that are generally not being impacted by what’s happening with interest rates and economic cycles,” he says.

Three examples of businesses Insync likes that are firmly entrenched within these megatrends are:

* Zoetis (pet humanisation) — a leading animal health company, with over 70 years’ experience in innovating ways to predict, prevent, detect and treat animal illness. The company’s portfolio and pipeline of medicines, vaccines, diagnostics and technologies are used in over 100 countries.

* Louis Vuitton Moet Hennessy LVMH (premiumisation) — a globally well-known French fashion house that produces a range of luxury products, ranging from bags and leather goods to ready-to-wear shoes, perfumes, watches, jewellery, accessories, sunglasses, and books.

* Adobe (enterprise digitisation) — a multinational computer software company that specialises in software for the creation and publication of a wide range of content, including graphics, photography, illustration, animation, multimedia/video, motion pictures, and print. 

“We believe megatrends have low sensitivity to economic cycles and grow at multiples of GDP,” says Monik. “What makes stocks grow over time is earnings growth. Consistent earnings growth is what drives share prices up over the long-term. That’s why we look for secular growth companies within these megatrends that have high levels of profitability, and are relatively well positioned in an environment of higher inflation and slowing economic growth.”

Brad Creighton - Portfolio Manager, AMP North
Brad Creighton - AMP North
Hamish Tadgell is Portfolio Manager at SG Hiscock & Company
Hamish Tadgell - SG Hiscock & Company
Monik Kotecha is Chief Investment Officer at Insync Funds Management
Monik Kotecha - Insync Funds Management

We believe megatrends have low sensitivity to economic cycles and grow at multiples of GDP. What makes stocks grow over time is earnings growth. Consistent earnings growth is what drives share prices up over the long-term. That’s why we look for secular growth companies within these megatrends that have high levels of profitability, and are relatively well positioned in an environment of higher inflation and slowing economic growth.”

Monik Kotecha

Navigating a narrow investment market

When positioning its portfolios, SG Hiscock & Company believes that changing global dynamics will increasingly impact investors. Hamish Tadgell — Portfolio Manager at SG Hiscock & Company — says these changes are being seen in four key areas:

1. Rising geopolitical uncertainty — Rising geopolitical tension; a move from cheap and plentiful labour and energy, to greater scarcity and expense for both of these; and the move from globalisation to regional alliances.

2. Rising cost of capital — A reassessment of valuations, liquidity, and credit flows; and increasing tail risks for businesses. 

3. An uneven economy — Persistent inflation, which is creating an uneven economic impact across the economy. This has resulted in interest rate pain being felt by most mortgagees.

4. Earnings and margin pressure emerging — Margin and earnings impact is being felt unevenly across sectors, such as construction, hospitality, and the retail sectors all being highly stressed.

However, as the world changes, Hamish says there are opportunities for investors to take advantage of specific tail winds and emerging themes/trends in the market. Some of these themes include:

  • Inflation — Defensive consumer spending. (SG Hiscock likes: Endeavour Group)
  • Post COVID reopening and surging migration — The recovery in travel and tourism; student immigration; and a housing shortfall. (SG Hiscock likes: Auckland Airport, IDP, Mirvac)
  • Energy transition — This is a a secular theme that is not economically sensitive. This theme can be played out in a number of ways, from the growth in renewables to critical commodities (like lithium), through to energy service providers. (SG Hiscock likes: Infratil, Woodside Energy, Worley)
  • Essential services and infrastructure — This includes a number of different sectors with essential services linked to them, like healthcare and data centres. (SG Hiscock likes: Chorus, CSL, ResMed)

It’s a brave investor who will bet against the U.S., particularly in an era where many of the global champions are U.S.-based companies, and where companies like Nvidia, enjoy almost monopolistic pricing power in the delivery of artificial intelligence hardware and software.

Brad Creighton

Outlook for U.S. equities

Despite some fund managers forecasting a 10-year outlook for U.S. equity returns delivering 1-2 per cent per annum, Monik believes investors cannot disregard U.S. equities.

“Some managers are consistent their views that the U.S. will underperform other markets. It’s a view that’s probably been in place since 2017. However, I think investors have probably been too busy looking at aggregate earnings and not really understanding the structure of the markets, as well as the changes that have been happening in the global economy,” he says.

“If you look at many of the markets, they are full of cyclicals and economically sensitive stocks that are not benefitting from the megatrends that are delivering sustainable high levels of growth.

“And while I agree there are many parts of the U.S. market that probably won’t perform very well, when looking for businesses that can deliver growth and sustainable earnings, our analysis keeps taking us back to the United States. Just look at the artificial intelligence trend. By being underweight U.S., investors would have missed out on companies that were extremely well priced and positioned last year, and which are generating good earnings this year.”

Brad Creighton — Investment Strategist, AMP North — agrees. “It’s a brave investor who will bet against the U.S., particularly in an era where many of the global champions are U.S.-based companies, and where companies like Nvidia, enjoy almost monopolistic pricing power in the delivery of artificial intelligence hardware and software.”

We are now in a very different and polarised world. But while there may be a desire by China to de-risk by reducing its iron ore dependency on Australia, can it actually achieve that? When it comes to iron ore, countries are looking for the highest quality available, and there aren’t too many countries that offer quality and certainty of delivery other than Australia.

Monik Kotecha

U.S./China relationship

As the U.S. seeks to de-risk from China in areas like technology on the grounds of national security, similarly, China is increasingly looking to de-risk from the U.S. and its allies. Potentially, this could affect Australia with its lucrative exports of iron ore. However, Monik believes that these de-risking policies are often hard to implement.

“We are now in a very different and polarised world. But while there may be a desire by China to de-risk by reducing its iron ore dependency on Australia, can it actually achieve that? When it comes to iron ore, countries are looking for the highest quality available, and there aren’t too many countries that offer quality and certainty of delivery other than Australia,” says Monik. 

“In terms of technology, the U.S. clearly remains the leader when it comes to the development and advancement of technology. And while China may catch-up with the U.S. on technology, we still believe there is a very significant gap that China needs to bridge. That gap will take time to close, so it’s unlikely China will be able to reduce its need for U.S. produced technology anytime soon.”

When it comes to geopolitical risk, Hamish believes we are increasingly moving to a world of alliances between countries. He says resource security is a growing strategic issue for governments, whether that’s around microchips or mineral resources, like lithium and iron-ore. All these resources are critical inputs for the modern day economy.

“China is aggressively investing in the Simandou mine in the West African country of Guinea, in order to build a world-class iron-ore facility. But these types of projects do take a long time to complete and are very complicated undertakings. However, if this is achieved, there is some risk that China’s demand for Australian iron-ore may decrease,” says Hamish.

“But investors need to remember that the only competitive advantage a commodities business has is where it sits on the cost curve. Australian producers are at the bottom of the cost curve and, based on the figures we’re seeing on the Simandou operation, Australian producers will remain there, making them highly competitive.”

But investors need to remember that the only competitive advantage a commodities business has is where it sits on the cost curve. Australian producers are at the bottom of the cost curve and, based on the figures we’re seeing on the Simandou operation, Australian producers will remain there, making them highly competitive.

Hamish Tadgell

A better environment to invest in

While the likes of bonds and term deposits are now offering reasonably good yields, Monik believes the current environment is also holding up for equities, providing more attractive conditions for investors to be in.

Although accepting there is a place for various asset classes in a total portfolio solution — depending on the investment objectives and needs of investors — Monik remains bullish on equities, and particularly with those businesses that can thrive in any interest rate environment.

“Clearly, when interest rates became very low, a lot of lower quality businesses got extended valuations, which created a bubble for unprofitable growth stocks. However, businesses that are protected from interest rate cycles are able to sustainably grow their earnings.”

In terms of equities, Monik says on average they have delivered 9-10 per cent compound returns over the long-term. That’s because unlike bonds and cash, companies are able to reinvest in their operations, enabling their earnings to continue to grow, making the total return potential with equities very attractive for investors.

“Therefore, for the right types of stocks, equities is still an appealing asset class to be in. I certainly wouldn’t be advocating for investors to suddenly sell down their equities to buy bonds or cash, because by doing so, they may actually end up with a return that doesn’t meet their required investment objectives,” says Monik.   

About

Monik Kotecha is Chief Investment Officer at Insync Funds Management; and

Hamish Tadgell is Portfolio Manager at SG Hiscock & Company.

They provided an update of ‘International versus domestic equities’ at an IMAP Specialist Webinar Series.

This webinar was moderated by Brad Creighton — Portfolio Manager, AMP North.

 

 

 

 

 

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