Onwards and upwards

2017 was a strong year for equity markets following the age of caution that characterised the post-financial crisis world. This has important implications for earnings globally and the strong returns experienced last year were underpinned by impressive earnings growth. In fact in Europe, we saw earnings growing for the first time in six years. A point to illustrate the recent resilience of global markets is that 2017 was the first time on record which saw the MSCI World Index (in local currency) generate positive returns in all twelve months of the year.

Our approach

This backdrop has been much more constructive for our fundamental stock picking approach. While the trust introduced a new dividend policy in 2016 – paying out at least 4% of the net asset value set at the start of each financial year – it is important to note that there were no changes made to the underlying investment process. We continue to have the freedom to invest anywhere in the world in the best ideas from across our team of seventy in house research analysts.

We look to build a portfolio of high conviction stocks which offer an attractive valuation signal, demonstrate profit growth potential, possess an identifiable catalyst and satisfy a timeline horizon. Our focus is on the long-term cashflow and earnings potential of companies and we draw on a common framework which allows us to compare our valuation insights across global sectors in a consistent manner.

Opportunities in retail

Today this approach leads us to find interesting investment opportunities in a number of industries around the world, for example in retail, perhaps somewhat controversially in the wake of perceived industry damage inflicted by Amazon.

Short-term weakness in the retail sector has provided opportunities to buy the likes of O’Reilly because despite Amazon moving into the auto parts business, O’Reilly has some very significant advantages that will make it very tough for Amazon to make rapid progress in the categories that matter to them.  O’Reilly has undervalued advantages in terms of the efficiency and breadth of their distribution system, the depth of their inventory and the reassuring presence of a high-touch high-service person behind a counter. 

Investing globally

Regionally our bottom-up process continues to result in large positions in Europe and the UK whereas North America is an area in which we are underweight. In the latter region, excessive valuation still prevents us from investing in bond equivalents and many other mega caps. Furthermore, being a global investor allows us to look past where a company happens to be listed and focus on the underlying business and drivers of earnings. In the UK, for example, many of the companies we own are international businesses that happen to be listed in the UK.

Outlook for 2018

Looking to the rest of 2018, the environment remains very positive for equity investing, particularly outside the US, where valuations seem a lot more reasonable and high operational leverage, particularly in Europe and Japan, will see companies benefit from better nominal growth. In the US, the economy has entered the later stages of the economic cycle given the economy is now close to full employment, but the risk of an imminent recession appears low and forecasts of continued earnings growth in 2018 look to be very much on course.

With stock correlations at low levels, this presents attractive opportunities for bottom-up stock pickers. We expect this backdrop to continue with a continued, synchronised global recovery in earnings. Investors should expect this to reinforce the economic cycle as companies become more willing to invest in capital expenditure and labour, especially in the US and Japan where reform packages aim to encourage this.

However, this environment is not without its risks; higher equity valuations—and the absence of a significant market correction for quite some time—mean investors should guard against excessive risk taking.