Reasons to be cheerful in 2018

John Husselbee, Olly Russ, Jamie Clark, Mark Williams, Anthony Cross, Peter Michaelis & James Inglis-Jones

Stock markets reached record highs in 2017 as the second longest bull market in history continued. This strong equity performance was generated in spite of another year of global political uncertainty and rises in interest rates in the US and the UK. Can this positive environment for stock markets continue? Liontrust fund managers highlight data, trends and analysis that provide reason for investor optimism in 2018.

Bull markets do not simply die of old age

John Husselbee

John Husselbee, Head of Multi-Asset: Bears are increasingly talking about complacency and markets running out of steam but we continue to believe there could be plenty left in the tank. This comes down to a question of duration versus magnitude: concerns are growing that since we are nine years into a bull market and the economic recovery has taken longer than the typical five or six years, we must be late in the cycle. We would dismiss the idea that bull markets can simply die of old age; it is the magnitude of the growth that is important rather than the length of the run.

One example from recent history proves this point: the so-called 1990s bull run actually stretched for 12 years, from 1987 to 1999, during which the FTSE 100 rose close to 340%. In the current post-2009 run, the index is up around 90% so no one can claim we are in a situation without precedent, at least when it comes to rising markets.

Bull markets do not simply die of old age


Highest European EPS growth in seven years

Olly Russ

Olly Russ, fund manager, European Income team: It looks like 2018 will be the year when the European economic recovery really becomes established. Having lagged the US and UK (in aggregate) for so long, the long-awaited recovery has finally arrived this year, and seems likely to be reinforced in 2018. As this chart shows, 2017 experienced the highest earnings growth rate for seven years as analyst forecasts proved far less susceptible to the serial downgrades which had characterised the previous few years.

The eurozone has faced two huge, almost existential, crises in the last decade: first the Great Financial Crisis, and then the Eurozone Crisis, which was a development of the former, but not suffered by the rest of the world. This has held back economic and earnings progress in Europe for far too long, but finally we should see pent up demand burst through – capacity utilisation in the eurozone is now at 83.8%, having risen from a low of 69.5% in 2009, and is very close to the 2007 level.

The second element to watch out for is the global effect of the end of quantitative easing (QE). The European Central Bank (ECB) will begin to wind down its QE programme this year, and global QE on a net basis will fall to near zero by autumn. Investors will then find out to what degree financial markets have been sustained by money-printing, and if increased global growth is sufficient to take up the slack.

Highest European EPS growth in seven years


Tightening labour market is a sign of economic strength

Jamie Clark

Jamie Clark, fund manager, Macro-Thematic team: The chart demonstrates the increasing recruitment difficulties in 2017 for the 700+ UK businesses that take part in the Bank of England survey. Why is this a cause for cheer? The tightening of the labour market is consistent with economists’ estimates of a UK economy operating at full capacity and bodes well for pay growth. UK unemployment dropped to 4.3% in October 2017 (data which were released in December 2017), the lowest level since the mid-1970s.

Pay growth will soften the present squeeze on real earnings and would also imply that the deflationary pressures of the last decade are ebbing, economic conditions are normalising and interest rates and bond yields will push higher. In such an environment we think that ‘value’ stocks are likely to benefit, and have positioned portfolios with this in mind. Intuitively, one would expect value stocks to be more sensitive to the economic cycle and empirical evidence shows that value indeed performs well in a world of rising interest rates, inflation expectations and bond yields.

Tightening labour market is a sign of economic strength


Attractive Asian Valuations

Mark Williams

Mark Williams, fund manager, Asia team: A global environment of muted inflation with low but stable growth should allow Asian equities to continue to perform well given their attractive valuations. The MSCI Asia ex-Japan Index trades on a price/earnings ratio of 13.2x based on Bloomberg’s consensus analyst estimate, which compares very favourably with other regions: the US is on 18.9x and Europe 14.9x.

Within Asia’s attractive average valuation, however, there is substantial variation by country, sector and stock. So while South Korea looks cheap given the progress it is making in reforming its corporate culture, Australia and India appear fully valued. China remains the regional growth engine, despite the gradual slowdown which goes hand-in-hand with its transition to a more sustainable path of development. Although the Chinese economy is decelerating, we believe the investment opportunity is expanding for those who are able to differentiate between the companies that will benefit from the economic transition and those that stand to suffer.

Attractive Asian Valuations


Global patent trends a reminder that man’s ingenuity underpins economic growth

Anthony Cross

Anthony Cross, fund manager, Economic Advantage team: Patents are designed to encourage economic development by allowing the financial benefits of innovation to accrue to the inventor for a specified period before the information enters the public domain. There is a balance to be struck on the length of patent protection – between incentivising innovation through longer periods and widely disseminating the benefits sooner through shorter patents.

To the extent that patent applications are a proxy for productivity improvements and future economic growth, the trend is very encouraging. Data from the World Intellectual Property Organisation and RWS Holdings, the world’s leading provider of patent translations and intellectual property support services, shows a strong upward trend in patent applications in recent years. This reminds us that secular growth in man’s ingenuity cuts through the cyclicality of different economies in the long-run. We expect this trend to be extended when 2017 and 2018 data is released.

Patents are a form of intellectual property, and this is one of the core intangible strengths we look for when investing in companies. We are also investors in RWS Holdings itself. RWS possesses strong Intellectual Property through the know-how of its skilled translators, who often combine both a language and a scientific academic discipline.

Global patent trends a reminder that man’s ingenuity underpins economic growth  


Electric vehicle sales to accelerate

Peter Michaelis

Peter Michaelis, Head of the Sustainable Investment team: We look forward to certain key trends becoming more evident in 2018. The take up of electric vehicles, for example, is likely to accelerate as they become cheaper and better performing. The image below shows BMW’s sales of electrified vehicles rose 64% year-on-year in the first 11 months of last year, compared with its total sales growth of 3.6%. Solar and wind technologies will also see prices come down, meaning they continue to be the dominant form of new investment for electricity generation.

Innovation in healthcare continues apace and we should start to see the advent of effective gene therapies – a whole new means of treating and curing debilitating hereditary conditions. As more of our lives (and money) are spent online, so the demand for security services will become even stronger.

These are some of the themes that underpin the growth of companies in the Sustainable Future portfolios. The macroeconomic outlook for 2018 also looks supportive: some inflation, gradual raising of central bank rates, and a continued modest global economic expansion.

Electric vehicle sales to accelerate

Companies with good cash flows look cheap

James Inglis-Jones

James Inglis-Jones, fund manager, Cashflow Solution team: The prospects for companies with good cash flow generation look healthy. Last year, much of the rise in equity markets was driven by companies that have high forecast growth rates but don’t necessarily have robust cash flow. As we highlighted in our Reason to be Fearful Halloween chart, these kind of stocks are now very expensive relative to their historic average.

The counterpoint to this is that companies with strong cash flow characteristics but more mundane growth forecasts are looking cheap by historic standards.  Last year was rather mediocre for these cash generative stocks as investors instead focused on the aforementioned stocks with ambitious growth expectations. The outlook for 2018, however, is much stronger. The chart shows that the average company in the top quintile of our quantitative cash flow screens is now trading on a composite valuation which is below its historic (27-year) average.

Companies with good cash flows look cheap

Key Risks & Disclaimer

Please remember that past performance is not a guide to future performance and the value of an investment and any income generated from them can fall as well as rise and is not guaranteed, therefore you may not get back the amount originally invested and potentially risk total loss of capital.

This Blog should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust.

Thursday, January 4, 2018, 9:32 AM