Markets have been volatile in 2016. First a crash and then a recovery that’s erased all the stock market losses dragged the Aussie dollar back to 76 cents, crude oil to $40 a barrel and drove a stupendous rally in iron ore.
But with all the ructions, fear, and more recent ebullience of traders, there is one constant that hasn’t changed and might actually have worsened. That is, the global economic environment remains one of consistently weak growth in the developed world with coincident sticky low inflation.
Now that the sugar hit of central bank monetary policy and quantitative easing appears to have passed, and now that excess stock market returns are likely to revert to stock specific – rather than market-based approaches – the art of portfolio construction is likely to come back into its own.
Recently Business Insider sat down with Will Low, Nikko Asset Managements head of global equities and Iain Fulton, Nikko’s investment director to discuss their approach to stock picking in this environment.
Low told Business Insider that because the “tailwind of rising risk asset prices raising all valuations was at an end. And because a large amount of expectation was reflected in the average share price the test this year was will growth be delivered”.
That’s partly why we saw the big fall in markets in the first five weeks of 2016.
Traders and investors started selling because they were wondering exactly that. Could a low global growth environment deliver on the valuation embedded in the prices of risk assets – stocks, emerging market debt, commodity prices, foreign exchange rates and so on?
While recognising that overall market atmospherics are still important for returns, Nikko follows an approach they call “future quality” which tries to identify stocks that will outperform the market. It’s not a Ben Graham or Warren Buffett valuation style approach, Iain Fulton told Business Insider. Rather, he said there is a subtle difference in the way they identify stocks.
Companies Nikko looks for “are businesses where the future cash flow, growth and franchise quality are not reflected in today’s share price.” They can come from any sector of the economy and stock market and “can be sourced from a range of recognised buckets such as growth, defensive growth, cyclical growth and restructuring,” Low said.
But because this is a bottom-up, stock picking method of portfolio construction, Fulton also said the companies that fit the profile “will also have catalysts that are very stock-specific and not just dependent on broader economic trends.”
That is, these companies will be able to grow their business, and hence their value, even in the current low growth environment.
Fulton gave us two very different examples of this concept in action.
He said companies like Facebook and Tencent still had significant upside because of the strength of their businesses and the under allocation by advertisers to the mobile ad market “relative to the amount of time people spend on their phones.”
He said the big opportunity for these two companies comes because mobile ad budgets were currently around 10% of total ad spend against the 25% of time people interact with their phones. TV and Internet were much higher in comparison.
That means that as advertisers start to spend where the customers are the revenues – the future growth – of these companies, and others like them are poised for growth in revenues and hence “future quality”.
At the other end of the spectrum, Fulton said that Tyson Foods, a US based chicken, beef and pork company with 21%, 24% and 17% of US market production in each of these markets, had come onto Nikko’s radar of future quality because of a transformative acquisition.
Tyson Foods had always been viewed as a cyclical business but with the acquisition of the Hillshire Farm business and brands it had moved into the pre-packed market.
In doing so, Tyson is able to increase margins and improve the quality of cashflows through time which “will lead to a higher valuation” for the companies shares, Fulton said.
Three companies in very different markets offering future quality and hence enhanced valuations in the future.
But they all share some common traits, Low said. They are “businesses where the future cash flow, growth and franchise quality are not reflected in today’s share price.”
“Disruptive growth is one thing. But we look at individual stocks and how they are changing” to identify opportunities, Fulton added.
And that is the message for individual investors trying to construct a stock portfolio in a low growth but extremely volatile environment. It’s not just about disruption.