by Tom Stevenson, Investment Director at Fidelity
21 March 2016
There are two ways for investors to look at the world. You can start from 30,000 feet, taking in the big picture and working out which specific investments chime with your top-down analysis. Alternatively, you can run the rule over individual companies and derive a world view from that bottom-up research.
Neither is right or wrong but the top-down view does tend to dominate commentary about financial markets. It’s what the big investment banks provide and the story-hungry media demand. The bottom-up research tends to be done by asset managers who are more cautious about sharing their insights. Understandably, they see their access to companies and their research capability as a competitive advantage.
Every year, however, we at Fidelity analyse the 17,000 or so company meetings we conduct each year. We question nearly 200 of our analysts around the world and aggregate their answers to build a bottom-up picture of the world on the basis of five key areas: how confident company bosses are and how they view the outlook for dividends, capital expenditure, their balance sheets and industry returns. These despatches are a great sanity check for the more common macro views.
So what is this year’s feedback telling us about the world? At a time when everyone from Janet Yellen to the strategists at Morgan Stanley are painting a progressively bleaker picture of the global economic outlook, what do things look like at the company level?
We found sentiment weaker across the board although, contrary to the general air of gloom, it’s no worse than neutral this year. Company fundamentals are neither improving nor deteriorating on average even if the outlook is only improving in one country, Japan. Europe and the US are pointing to a maturing economic cycle but there is no evidence at the corporate level that a fall into recession is imminent.
In the emerging world, Asia Pacific scores most highly with the exception of China. The biggest concerns are in Russia, Eastern Europe and Latin America, where sentiment has collapsed.
If you delve into individual sectors you can see why emerging markets are under the cosh. The sectors where sentiment is strongest are those in which developed markets have a competitive edge: IT, consumer staples, healthcare and telecoms. At the other end of the spectrum are the sectors on which emerging markets depend: energy, materials, utilities and industrials. Interestingly, just one sector shows better sentiment than a year ago: consumer discretionary.
There’s a clear divergence between what might be called the new and the old economies. With capital spending under pressure all over the world, traditional heavy sectors are struggling. But the outlook for technology and innovation-focused industries, as well as for consumption, is much better.
Some key themes emerge. The first is the ongoing impact of over-investment and excess supply. Persistently low commodity prices have triggered dramatic cuts in capital expenditure and these reductions are expected to continue this year. To begin with companies tried to weather the storm but only the strongest and most diversified have been able to. As a result dividends, as well as spending and jobs, are at risk. Sustainability of income has become a key focus.
A second emerging theme is the potential for new technologies to disrupt existing markets. The accelerating pace of change in the world today is an increasing challenge for investors, making careful analysis ever more important. The divergent fortunes of true innovators and the market as a whole – and within sectors between those who can capture the benefits of innovation and those that are left behind – make investing more about stock-picking than ever.
While consumption is emerging as the engine of growth in the developed world, here too innovation is sorting out companies in a ruthless way. This is illustrated by the way the contribution to overall US retail sales of Amazon.com and Walmart are heading in opposite directions.
The final message from our analysts is that risks are rising. The companies they talk to worry about flagging demand, a lack of pricing power, regulatory interventions, ineffective or harmful policies and the growing risk of disruptive competitors. Rising risks mean capital preservation is a priority – return of capital matters as much as return on capital.
The conclusions: growth is becoming scarcer, selectivity is key and understanding the winners and losers of innovation and disruption has never been more important. The margin for error is fine and as an investor you want to find out what is going on before it shows up in the official data.