The outlook for 2015

Lucy MacDonald discusses Brunner’s approach to ‘managing the risk of the unknowable’.

Lucy MacDonald, Manager, Brunner.

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The type of spike in volatility that unsettled markets in October is likely to be more commonplace in 2015. After three years of declining volatility this will be a challenge for investors.  However this should not prevent equities outperforming bonds and cash again in 2015 even if returns are quite muted. After a marked outperformance of the US over Europe in the past year there is a good chance that Europe offers better prospects in the year ahead. The oil price will probably remain under pressure short term but should stabilise during the year as supply is gradually curtailed.

The most positive factor supporting markets will be continued central bank liquidity injections through some form of quantitative easing. Whilst the stimulus from the Fed will be lower in 2015 there will be support from the Bank of Japan and the ECB is under rising pressure to act further.  The rapid fall in oil prices will support consumer spending. Corporate earnings are growing around long run averages this year, with solid performances from Technology and Healthcare outweighing disappointment from Resources, and the US experiencing fewer downgrades than average coupled with significant buyback activity. Revenue growth remains a challenge in the constrained nominal growth environment. Margin upside will be limited outside beneficiaries of lower oil prices.

While relatively benign, the outlook is not without risks. Geopolitical tensions will be fanned by competitive currency devaluation and the impact of lower oil receipts in some regimes.  In the UK, the coming General Election looks to be a close contest and will create uncertainty over the relationship with the EU.  The Fed will need to communicate the path of US monetary policy with some skill to avoid excessive volatility in the bond market, where rate expectations are currently quite complacent. The rebalancing of the Chinese economy away from a reliance on investment and debt is far from complete and could have ramifications for property prices in the region.  In absolute terms the valuation of equity markets are above long run averages which in itself is a good reason for some caution.

Our investment approach is to find stocks with the potential for structural growth, with good cash returns, strong management and balance sheets. We seek to buy these stocks at a valuation where these favourable characteristics are not fully priced in.  To aid our idea generation, we have access to a global research platform which includes traditional fundamental analysts, supplemented by non-financial market based research and specialist environmental, social and governance (ESG) input.

 We interact with our global investment colleagues via a social network we have developed with salesforce.com, which enables a 24 hour global conversation to take place as we review and assess the attractiveness of various investment ideas. Our focus is on buying good quality companies at the right time and at the right price has enabled us to deliver to shareholders in the Brunner Investment Trust meaningful capital gains and a 42 year history of consistent dividend growth.

In a concentrated stock picking portfolio such as Brunner’s, the opportunities lie with the fortunes of the companies we invest in. We continue to favour stocks that can grow their businesses and dividends even if economic growth is muted.  These stocks can be found globally in industrials, healthcare and technology, although Europe in particular is now a good hunting ground for undervalued growth companies.  Lower oil prices and rising wage inflation provide a better backdrop for consumer stocks. M&A activity and management self-help might well offer good returns in selected UK small and mid-cap stocks.

It should be noted however that predicting the future is very difficult. Harold Macmillan famously remarked to a journalist, when asked what is most likely to blow governments off course, “Events, dear boy, events”.  Managing the risk of the unknowable is best done via a portfolio of good quality companies at reasonable valuations.