Fears over a global recession are overdone, but it is clear we have entered a period of slow growth domestically in the US and internationally.
From a bottom up perspective, we are somewhat cautious on the market currently; we do not anticipate seeing much earnings growth or free cash flow growth. We believe that fundamentals currently are not looking overly solid.
It would not surprise us if the market traded sideways to down over the course of 2016. This is why we remain overweight in utilities and consumer staples. These sectors offer a degree of safety and also offer attractive capital return characteristics. The commodities sector remains in a tough spot, with an oversupply of oil and natural gas in the US.
Given US equities currently trade at the top of their historical valuation range, we believe market upside going forward will be more closely linked to earnings growth, a dynamic facing numerous headwinds. Strong sales growth should protect company margins from the negative effects of rising interest rates and rising labour costs. However, sales growth levels for US companies have clearly weakened over the last several months, primarily due to the impact of a strong dollar and weaker levels of demand in international markets. Companies have responded by reducing costs and succumbing to financial engineering. There is a risk some of the tailwinds that lifted corporate earnings in recent years may abate in the forthcoming years.
The equity environment will favour active managers with a demonstrated ability to deliver value through stock selection. Reasonable valuations, moderate and steady growth in the US economy and strong corporate fundamentals suggest equities remain a sound longterm investment. The current environment is attractive for free cash flow oriented investing. Balance sheets are healthy and free cash flow generation remains strong. As a result, management teams have a significant opportunity to create value for shareholders by allocating capital effectively. Dividend increases, share repurchase programs, cash accumulation, debt retirement, organic growth initiatives, selective and highly accretive acquisitions – all can accrue to the benefit of equity holders.