Salt looks to valuation and thematic support in 2024
At the start of the year global equity markets are happier but pricier, says Salt Fund Management in its Global Outlook report for January 2024.
Thursday, February 1st 2024, 6:57AM
by Andrea Malcolm
November and December’s strong global markets pushed some major indices into the expensive end of their historical ranges although emerging markets and Europe remain historically cheap.
Overall, for the next three years, equities could see average annual returns close to their long-term norms with interim weaker periods but selected sectors and markets have scope for resilience, says Salt strategist Greg Fleming. Those are all-weather stocks and defensive sectors that have lagged in recent years.
“For instance, listed real assets have superior, defensible yields, in a fraught macroeconomic and geopolitical phase.”
Real asset’s historical sensitivity to bond yields (as they trend down) could be supplemented by their cashflow surety, inflation-hedging qualities and (for infrastructure) non-cyclical defensive merit, he says.
“Bond yields have adjusted well, and may now plateau, which is positive for real estate looking forward one year, while Infrastructure may need weaker economies to again outperform as it did in 2022.”
Within the broader market sectors, utilities and consumer staples, healthcare, and software as a service (SaaS) have pricing power which is helpful for riding out sentiment storms and hedging against economic slowdown.
So what of the tech giants and those companies in the AI-robotics-web 3.0-crypto nexus?
“Investors with a long-term horizon might be comfortable with thematic exposure through specialised funds, but we think it is safer to allow the most agile and best resourced tech giants to demonstrate what they can achieve with AI, before committing to more than a nominal holding.
“Otherwise the risk is that pure enthusiasm on behalf of a corporate could easily lead to overpriced acquisitions which might ultimately have to be written down or written off.”
Fleming says Salt’s approach is to consider the quality dimension of any product or process before investing and not make heroic assumptions about the inevitability of any new tech necessarily making the grade on critical comparative tests such as return on operating capital and long-term earnings compounding capacities.
So even if profitability, productivity and generally transformative claims of emerging generative AI technologies can be shown, each individual equity should still be thoroughly assessed on the same metrics that have proven their worth for other parts of an individual portfolio.
For international equities Salt follows the investment process of its global partner Morgan Stanley Investment Management which is to identify high return companies with high unlevered returns on operating capital employed, high gross margins, capital light business models driving free cash flow generation and a strong balance sheet; make sure returns are sustainable; and to ensure management is committed to sustainable returns with a focus on return on capital rather than sales or earnings per share growth.
Fleming says Salt’s Sustainable Global Shares Funds holds only two of the ‘magnificent 7’ - Microsoft and Alphabet - while based on its investment process, chipmaker TSMC and Accenture also make the cut.
Despite Salt, along with most other asset managers, expecting an eventual soft landing globally, geopolitical risk makes it worth considering the classically defensive equity industrial sectors that weren’t swept up in 2023’s resumption of confidence: healthcare, consumer staples and utilities.
The report says to expect more M&A based on strong US dollar “war-chests” and also some corporate courtships to go pear shaped as conditions shift and credit-distressed firms multiply this year and next.
Fixed income
“We see better compensation for duration risk in bonds but yield levels will remain volatile. Within fixed income, thematic support is ready to be a prime differentiator, as sovereign and corporate bonds face refinancing risks. We acknowledge sustainable or “green” bonds as a valuable theme.”
Default risk and credit quality are now on the radar and are likely to become a market focus in mid to late 2024, setting off portfolio reallocations within and beyond bonds.
“We are now traversing the expected global slowdown as the lagged impacts of policy tightening around the world continues to impact the real economy, and asset markets adapt to protect existing capital gains by allocating funds toward “all-weather” securities.
“Such desirable investments, which we are actively seeking out across all our asset classes, are resilient to both inflation and to profit challenges in a less stimulus-based, capital spending and productivity-led phase of economic growth.”
Salt prefers international assets to domestic thanks to key northern hemisphere trading economies having more diversified defensive industries and often, more adaptive economic regulation while allowing that electoral / policy change risk is ever with us and will intensify this year with the US Presidential election in November 2024.
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