Interview with Alan Porter, Global equity income at Martin Currie (Legg Mason)
It has been an eventful, but largely positive, year so far for global equities. Against a backdrop where a number of macro factors have continued to drive global market sentiment, Alan Porter shares his thoughts from an equity income perspective for the rest of 2015.
In macroeconomic terms, the global financial crisis legacy of weak banks and high levels of debt continues to weigh heavily on spending and growth worldwide. More recently, inflation has declined, reflecting lower commodity prices and a reduction in demand. The oil price in particular has been weak. From a high of more than US$110 per barrel of Brent in July 2014, it dropped to a low of US$46 in early January (although prices then recovered to US$65 by late May).
Interest rates have, in general, reflected these movements. So too has monetary policy worldwide, put in place as governments attempt to spur on economic growth. This has included the much-anticipated quantitative easing (QE) programme from the European Central Bank (ECB), with c60 billion (£46 million) a month being pumped into financial markets via bond buying. Looking ahead, global growth is now expected to increase and macroeconomic risks have decreased slightly, but there is still the possibility of further financial disruption and geopolitical tension. A potential upside of the lower oil price is that it could spark a rise in consumer spending once again.
In corporate terms, the sector continues to see high and growing levels of cash flow, but capital expenditure remains stubbornly stable. While this may be good for shareholder returns in the short term, in the longer term we need to see greater confidence in the corporate sector to promote higher capital expenditure.
Although market valuations are high, they are not extreme and we are positive on equity markets at this point given their attractive yield relative to other asset classes. When corporate confidence returns and companies start to reinvest in their businesses, earnings growth will pick up and valuations will begin to look less stretched. It is just the timing and nature of how this unfolds that is still uncertain.
The key risk for the market in 2015 and looking ahead to next year is the potential for further financial disruption globally. Greece, for example, has been a focus of news flow throughout the year and as the country continues with severe cash constraints, a Greek exit from the Eurozone is still a possibility. Elsewhere, geopolitical tensions in other areas, such as the ongoing crisis in Russia and Ukraine and events in the Middle East, are also a worry for global investors. A lesser risk would be continued caution in the corporate sector, which could mean muted growth in capital spending. Despite enjoying high levels of cash flow, companies have not been increasing their capital expenditure.
As always, our strategy is based on the principles of bottom-up stockpicking. We concentrate on the prospects for individual companies, believing that over time the best businesses will be rewarded in terms of share price performance while fundamentally weaker ones will suffer.
It has been a positive first half of the year for global equities – this comes against a backdrop of gradually improving global growth. According to the International Monetary Fund (IMF) global output is forecast to grow 3.5% in 2015 and 3.8% in 2016. This is slightly up from growth of 3.4% in 2014.* In our view, this assumption of slowly improving growth is sensible – from a research point of view – though it is important to be sceptical of high-volume growth assumptions.
Expectations are for global earnings to rise around 3.7% in 2015 and 12.6% in 2016† and while energy and materials sectors are predicted to drag growth down this year, they will be driving it in the next year. This means prices for oil and other commodities are the biggest driver for short term earnings.
We would argue the risk to consensus estimates for earnings expectations is that while 2015 might be better than predicted, as we see a small recovery in commodity prices – as witnessed in oil so far this year – 2016 may fall short of expectations. There is unlikely to be a strong recovery in commodity prices next year given relatively weak global demand.
At the moment, global equity market valuations do look high relative to previous years, but they are not extreme when we look at historical price/earnings (p/e) and enterprise value/earnings before interest, tax, depreciation and amortization (ev/EBITDA) multiples. When focusing on dividend yields, these markets look in line with historic averages. In our view, the yield available is the strongest support to equity markets relative to other asset classes. The MSCI World High Dividend Yield index, which includes large- and mid-cap stocks across 23 developed markets countries is more attractively valued than the broader MSCI World index on both a p/e and dividend-yield basis.**
So far this year, the strategy is slightly ahead of the MSCI World High Dividend Yield index and is slightly behind the parent index, the MSCI World.
No. Turnover for the portfolio remains consistent, at around 30% (annualized). We have increased our exposure to US industrials and remain underweight healthcare.
As we carry out research into the stocks we own – and potential new holdings – there are a number of different issues we have focused on. One in particular is how do we best get exposure to the dividend recovery currently underway in banks in both the US and Europe?
We are focusing on European banks where QE has seen the financial sector repairing balance sheets. While there have been positive signs of economic growth as a result of QE in Europe, we have asked ourselves how long the cyclical rally will last. We are monitoring our cyclical European holdings to ensure we hold those that can see through the economic highs and lows.
With low commodity prices, particularly oil and iron ore, stocks in the energy and materials sectors have been particularly weak. When will the time be right to increase our exposure to these kinds of companies, if at all? This is something we will check on an ongoing basis. Finally, we are also monitoring our defensive exposure in the portfolio. These stocks, which provide stable returns regardless of the state of the market are currently, in our view, expensive.
In conclusion, there is a definite improvement in the macro environment as we move further into the year, but it still remains weak and volatile. Equity valuations are currently high, but not extreme, and their relative yield attractions are strong.
The strategy has performed well in the year to date and we are continuing to find new ideas. In order to achieve our target of finding the best global income stocks, our belief in our investment philosophy is as firm as ever. We believe companies which combine an attractive, sustainable dividend yield and dividend growth will perform well. Most importantly, the process of how we select these stocks remains clear, we look for a margin of safety in both dividends and valuations backed by in-depth insight as to why we believe a stock will outperform.
We believe investing on the basis of fundamental research-driven analysis is the best way to navigate the markets’ current conditions. We continue to concentrate on the prospects for individual companies, believing that over time the best businesses will be in a position to provide sustainable dividends, while fundamentally weaker ones will not.
*Source: International Monetary Fund World Economic Outlook, April 14 2015, IMF staff.
†Source: Global Market Intelligence, Global Equity Strategy Team, 5 May 2015, Citi Research. **Source: Bloomberg as at 26 May 2015.