The TAMIM Global Equity High Conviction IMA portfolio has managed to achieve impressive results since its inception. In fact, over one and three years, the underlying fund has outperformed the major Australian based international equity funds. This week Robert Swift takes a look forward to 2017 and gives a sector outlook heading into the festive season.
Looking Forward to 2017 & Global Sector Outlook Robert Swift - December 2016 -
Unbelievably 2016 is almost over! Time seems to slip past faster than ever.
No one investing today has seen what we are confronted with now. We are in uncharted territory. Central banks own private sector debt at unprecedented levels. GDP growth is sluggish despite years of easy money and low interest rates. Budget deficits in some countries are enormous and intractable, and there are clear signs that the "peasants are revolting" (also known as populism) in ways which cause the whole basis of global trade and capital flows to be in doubt. Governments and their agencies are intervening in capital markets in (a vain) attempt to trigger a sustainable uptick in economic activity believing this is all that is needed to quell the populist uprisings.
We don't want to say more than one thing about this increased intervention in capital markets. Central banks are not mandated to determine solvency. They are there to provide liquidity when needed and at a penalty rate. What we have endured in the last 10+ years is central banks determining solvency and interfering in price and price discovery. We haven't been fans of ZIRP and other nefarious tricks used by central banks and politicians to inflate the banking soufflé and to kick the can down the road. We are glad it appears to be drawing to a close since it has failed and only created more asset ownership inequality. After that mixed metaphor of souffle and cans let's move on?
This political intervention has caused absolute and relative price anomalies in and between asset classes but although volatility is consequently elevated there is a lot of opportunity out there for active investors. The brutal truth is that equity returns may be in high single digits for a while and come with high volatility as these imbalances are resolved. The days of 15% per annum without too much risk, are probably gone. Consequently it is important to focus on managing risk or volatility of return, to turn your savings into a bigger pension pot.
Here is what we are planning for 2017 from an investment perspective. We use a stock selection model which ranks companies on a variety of attributes such as valuation and earnings quality. We also have a slightly different model we use to identify attractive and unattractive global sectors. This helps us decide which sectors are more likely to outperform than others and gives us an additional insight into whether we have the right kind of companies in the TAMIM Global Equity High Conviction portfolio. The difference is useful because it gives us a different signal from the VMQ approach. Using two sets of differing signals which both work, adds robustness to the model. Value momentum risk sector output shown below is a ‘kissing cousin’ of VMQ but not an identical twin.
We revisited this model with a view to planning for 2017 and the results are shown graphically below. Anything to the right of the vertical line is expected to outperform; anything to the left underperform. The length of the line gives some expectation of the extent of the out, or under, performance.
This sector work is the output of our models. It is a starting point not the end point of a decision process. It is a useful starting point. As we say in our marketing materials - "not everything that can be counted counts; and not everything that counts can be counted". Actually it was Albert Einstein who said this but it is a perfect description of how we use quantitative modelling in our portfolio management. It helps but you can't use numbers alone and you have to relate the numbers to the real world.
Let's look at the sectors which stand out rather than everything.
Banks & Diversified Financials: This was a great theme from 2016 especially North American financials but we think there is more to go and the Europeans may be about to "get it". Banks need more capital and a positively sloped yield curve and not negative interest rates. The end of ZIRP will help. We purchased BNP Paribas in France and Julius Baer in Switzerland recently and are still heavily invested in Financials. The risk is the collapse of the Euro which is frankly a poorly constructed doomsday machine and one of us has said this since its formation in the 1990s. We can tell you that you will know more about ‘Target2 balances’ in a few months because that will be all over the media in short order. What are ‘Target2 balances’ we hear you ask?!!
Technology, Semiconductors: Another sector in which we have been heavily invested favouring large incumbents over smaller single product companies. There are signs of an uptick in the PC market and a significant business model shift toward cloud based sales and recurring revenue models. The $64bn question concerns Apple, which we own. What will it (or Donald Trump) do with its cash pile and is there life after the iPhone? We currently think ‘something sensible’ and ‘yes’ in that order but it’s harder to grow a business the bigger it gets. We also expect continued M&A and fully expect telecom companies to want a piece of the action in ‘The Internet of Things’.
Industrials: This is an eclectic sector but companies that make things, repair things, and design things, will be enjoying a renaissance. We like reading research produced outside the usual financial community since it provides a less biased story. The American Society of Civil Engineers (ASCE) produces a quality quadrennial report, next due in 2017, on the state of USA infrastructure. You wouldn’t want your children to get the grades that the ASCE gives USA roads, railways, dams, and the electricity grid etc. Check out www.asce.org. It’s rated “R” if you care about sustainable growth! The USA can’t afford to ignore this problem much longer if GDP growth is to achieve its potential. Europe is also on a pathway to higher public spending and we think much money will be spent on railways and green energy. It’s a great sector in which to be fishing for ideas. We own Honeywell in America and Toray in Japan which is a carbon fibre tech stock on an industrial company P/E rating.
Household Sector, Food and Beverage, and (Food) Retailing: This doesn’t look too strong to us. Primarily because investors have flocked there in the last few years and driven the prices higher; probably too high such that the future risk adjusted return will disappoint? We think so. They aren’t bad companies, nor badly run but they are expensive and there is a good chance that “everything is in the price”. On our model these are expensive companies, widely owned and vulnerable to disappointments. We also note Food and Household goods companies have invested heavily in emerging markets and so there is a risk there that may require a re-evaluation? Currently China, India, and other emerging market economies are under pressure and currency translation effects could be negative. As for the retail sector the prospects look difficult. Consumers are faced with limited wage growth, mediocre job security, and inflation for healthcare expenses which eats away at disposable income. Oh and higher direct or stealth taxes on individuals are very likely unless “drain the swamp” meant a policy to be implemented rather than a useful phrase!
We own Macy’s which is part retailer and part property company. It is certainly a turnaround story and if management fails to turn it around there are enough assets to promote a bidding war. Big Box retailers in the USA are under pressure and the retail malls are also thinking about how to best use their space to better compete with the online commerce threat clearly posed by Amazon Google etc. Should be interesting. Given the increasing cost of destroying the high street by removing tax revenues and community spaces it is not clear to us that the physical spaces will die nor remain without their proponents. We wrote a piece concerning this recently.
Real Estate and Utilities: These have been sold off and look ok to us. For various reasons we don’t believe interest rates rise enormously and so as share prices fall and dividend yields rise these could become attractive as 2017 progresses? We think of them as index linked bonds with rising coupons. They will represent great inflation hedges at some point. The telecom companies are even finally thinking about how to enter the “Internet of Things” and monetise their enormous subscriber base with more products. The Verizon interest in Yahoo is indicative of that.
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