Economic & Market Commentary - Choppy Waters, Doctor Copper And Technological Revolution

A quote from the renowned American investor and writer, Howard Marks, sets the tone for this month’s commentary:

“The best response when seas are choppy is to focus on completing the long-term voyage and not think about whether the next wave is going to push the nose of the boat up or down.”

Despite a degree of nervousness following the falls in equity markets in the fourth quarter of last year, global stock markets have continued to edge higher in March, albeit with an element of gentle volatility of the type favoured by active fund managers. Increased volatility across different asset classes is often accentuated by the prevalence of quantitative strategies and a rising proportion of investors chasing short term returns. Volatility at individual stock level, although disconcerting for some investors at market and portfolio level, brings opportunity for the more astute active fund manager who is willing to look beyond short-term market hype and buy the shares of good companies at lower prices.

Investors who heeded Mr Marks’ advice, and focused on their longer term strategy at the end of last year when many were blown off course by the “choppy waters” in financial markets, have been handsomely rewarded as stock markets have bounced back in the first quarter of 2019 and now look set to go even higher albeit accompanied by the friend of the active fund manager, volatility.

Although some economic indicators remain subdued and point to a slowdown in global growth, more positive news for investor sentiment has been the marked shift to a more accommodative stance from the US Federal Reserve. This has led to a rapid fall in interest rate expectations. Optimism surrounding a possible tariff resolution between the US and China has also helped sentiment.

The general improvement in the economic outlook is further supported by the signals from ‘Dr Copper’. The price of copper, often viewed as a bellwether for the global economy because of its wide range of uses in construction and industry, has risen by almost 10% this year to just short of $6500 a ton. This price increase had been supported by the thaw in US-China trade relations and a fall in inventories at the London Metal Exchange and copper producing countries.

In the UK, the uncertainty regarding Brexit rumbles on but despite a lack of political clarity, the pound and the stock market has remained relatively steady over the last month, with the risk of a hard Brexit scenario still deemed fairly low.

Despite elevated political noise, companies in the main are adopting a “business as usual approach” as demonstrated by company results which have come thick and fast in recent weeks. Operating performance is reassuringly robust with cash generation and dividends making good progress. It is also heartening to observe how most companies are just quietly getting on with their long-term strategic plans, despite operating in a world with no shortage of complexity and vicissitudes. In fact, it is interesting to note how similar the mindset of successful long-term orientated business management is to the approach used by long-term focused fund managers of the type favoured by Clarion. Like our fund managers, good business managers avoid trying to predict the short-term ‘chop’ of economic and political events, interest rates, inflation, elections etc. Instead they aim, as do Clarion, to look past short-term noise and develop investment plans that will help to insulate a company from a wide range of different challenges.

There has never been a better time to be exceptional or a worse time to be average. Average companies around the world are failing as larger, more efficient, competitors dominate them from above, and disruptive start-ups prey on them from below. Modern capitalism tends to create duopoly and monopoly market structures, and, at this stage, they are increasingly prevalent.

Despite, and partly due to, the extraordinary level of disruption, particularly from the broadly defined technology sector, many industries continue to consolidate. Cheap debt and easy access to venture capital funding seem likely to accelerate this trend for longer than many anticipated. Heavily consolidated markets benefit from greater bargaining power with suppliers and customers, more efficient cost structures, and high barriers to entry. All of which benefit shareholders through wider margins, more sustainable returns on capital, and higher cash conversion.

Companies caught in the middle of this battle royal are struggling. The strong get stronger and the weak get weaker. This trend seems set to continue for as long as the economy stays steady and interest rates remain low which seems highly probable. Expected future returns are lower and expected risk is higher and so portfolio construction and risk control are more important than ever.

The Clarion investment strategy remains broadly the same as in recent months and we continue to favour equities over bonds and cash. In bonds we retain a tilt to short duration bonds which are less susceptible to higher interest rates and inflation. We believe the 30-year downward trend in yields has bottomed if not yet turned. In equities we prefer UK, Asian and Emerging Market equities to Europe which has political and structural problems. In the US valuations appear stretched but some of the best companies in the world are American and it would be no surprise if profitability, return on capital and cash conversion continue to improve making the very best American companies even more valuable.

Brexit has delivered a potent cocktail of economic and political uncertainty. From the perspective of UK stocks this has been expressed in a record exodus from the asset class. This has resulted in investors being significantly underweight in UK equities at a time of near record relative value. Clarion believe this is unnecessarily gloomy hence we are confident that our strategy of increasing our exposure to good UK equity fund managers who invest in quality companies will continue to be rewarded.

In conclusion, we make no apology for using another quote, this time by Dr Sandy Nairn in an update of his 2001 book; Engines that Move Markets. “Technology is the engine that moves markets and civilization. The good news for investors and humans is that technology is secular and exponential–building on centuries of accumulated knowledge. The best is yet to come.”