Good conditions for global growth

There’s a great deal of discussion on Wall Street regarding stock market valuations right now. Are markets at the top or are they not?

The vicious correction in early February has convinced many investors that there is more bad news to come. It was triggered by a US jobs report showing improved wage growth, which fuelled inflation fears and markets spiralled downwards for 10 days. The correction brought an end to the longest period in history without a 5% decline in the S&P 500.

Gerrit Smit, head of equity management at Stonehage Fleming, does not believe that markets are set for a more serious correction. “The world is in a good place right now. Greenspan [chairman of the US Federal Reserve from 1987 to 2006] would be envious – he struggled to achieve this Goldilocks-type economy of low but consistent growth with low but consistent inflation.”

Besides, some inflation is good – it oils the wheels of the global economy, he adds. “The core inflation rate is 1.8%, that is hardly high. Only once inflation tops 4% do investors start adjusting valuations downwards.”

Wage inflation should not be a concern either. Historically wages increase for some time before they impact on corporate profitability. In addition, “we have not begun to feel the impact of technological advances brought by artificial intelligence, which will have a material positive impact on company performance. While wages may increase I believe other costs will be contained.”

Thus while valuations may seem high, Smit says there are many factors that are supportive of corporate profits. Also growth across the world is synchronised, and the US dollar is weak, making US exports cheaper and kick-starting US industrial production.

In addition Trump’s tax reforms will be beneficial to growth. The corporate tax rate has been reduced from 35% to 20%. And companies with an estimated $3.1 trillion of offshore profits, according to Goldman Sachs, have a window to bring those funds home – paying a nominal tax of 15% on them.

“As a result of the tax reforms, analysts have revised their expectations for US corporate growth from 13% to 20% this year,” Smit says.

Presumably a rising tide in the US is good for everyone else.

The Global Best Ideas Fund, which Smit manages, returned 30% last year, and was up 6% in January, usually a quiet month. Not a single share was sold during the February fall, instead Smit and his team sat on the fence until markets calmed, then using the opportunity to buy selected stocks.

The industries that have appeal at the moment are those demonstrating sustainable, organic growth, such as the technology, healthcare and consumer sectors.

Cosmetics firm Estée Lauder is a favourite holding. “Cosmetic usage increases as the economic base improves, particularly in the Far East – and the selfie generation is driving the consumption of cosmetics higher and higher.”

Tencent is the fund’s largest holding, followed by Visa, Google, Paypal and Accenture. “Accenture was astute when deciding to focus their consulting work on technology. They are experts in artificial intelligence, cyber-security and cloud computing. This is a sustainable business – as business and technology changes – so Accenture’s services are more in demand. IBM should have grown into this business, but it didn’t.”

He says he opted for Tencent rather than Naspers. “I look at organic growth – and Tencent grew its topline by 50% last year alone.” However he notes that the two companies have incredible synergy, with each company learning from the other. “For instance Tencent has invested alongside Naspers in Mail.ru in Russia and Flipkart in India.”

He adds that developments at Tencent subsidiary JD.com are worth watching. JD.com, which is Alibaba’s biggest competition in China, acquired Walmart’s online business in 2017 and is now providing real competition to Alibaba.

McDonald’s is another popular stock. It’s a food company with a property bent. “They sell a quality product with burgers that are guaranteed 100% pure meat, and eggs that will all be free range by the end of 2019. They own all their properties, which are rented to franchisees. The rental, which escalates annually, is used to pay the dividend, the franchise fee covers the operating costs. It is the best example of a property company where the landlord and tenant are 100% dependent on each other.”

And he gets in a quiet word about active investing. “By definition passive investing means you buy more of the stocks that go up and less of the stocks that go down. Therefore you are buying high and selling low. You end up fearing the market, because you cannot control it.”

The Global Best Ideas Fund has outperformed the MSCI World Index by 2% per annum since inception – after fees.

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