By Charles Stodart, Zurich’s Investment Specialist
Global GDP growth continues to languish, and the prospect of stronger growth in the future remains elusive. The OECD (the Organisation for Economic Cooperation and Development) has lowered its 2016 global economic forecast to only 3% growth, and despite low interest rates and oil prices, growth is likely to remain modest into 2017.
In this environment of ‘low growth’, subdued corporate earnings should not be a surprise. In the US, for instance, corporate earnings are slowing as company revenue growth takes a hit.
This presents a challenging investment environment for traditional ‘growth style’ managers. When growth is scarce, companies that can demonstrate a high and sustained rate of growth are priced at a premium. The risk here is that the investor ends up paying for growth that is already reflected in the share price.
Making a call on whether ‘growth’ or ‘value’ will perform better in a given market has traditionally been tough, and is normally only clear with hindsight. ‘Growth’, in this context, is defined as stocks that show high sales growth, high earnings growth and momentum. Conversely, ‘value’ stocks show low price to book value, and low price to earnings. In basic terms, ‘value’ stocks are priced more cheaply, typically to reflect lower growth prospects.
One observation of the performance of ‘value’ vs ‘growth’ since 2000, is that when inflation expectations are high, value stocks tend to outperform. This can also coincide with a period of tightening interest rates. The most recent period like this was 2004-2007 – the last time we saw sustained interest rate increases by the US Federal Reserve (the Fed), from 1% (in mid 2004) to 5.25% (in mid 2006) in 17 successive hikes.
Since 2008, muted expectations for both growth and inflation have proven to be a more favourable time for ‘growth’ stocks. This means that interest rates (or, more specifically, the US Federal Reserve rate) can be a reasonable proxy for growth, with higher interest rates typically matching higher growth. Conversely, a period of muted inflation expectations has also served as a reasonable scenario for when ‘growth’ stocks outperform ‘value’.
Given that the Fed raised rates for the first time in a nearly a decade in December last year, should investors take this as a signal that a traditional ‘growth’ style may soon struggle? While inflation remains subdued, and given the very shallow expectations for future rate hikes, it may be too early to make this call just yet.
But one way to sidestep the need to ‘call’ the market on whether a certain style is about to perform is to re-think the definition for growth. Perhaps the question to ask is not ‘what is a growth stock’, but rather to ask ‘when’ is a company a growth stock. This may seem like semantics, but it recognizes that the direction of growth can be more important than the absolute level of growth in determining future share price performance.
This is the approach of American Century Investments (ACI), the manager of the Zurich Investments Global Growth Share Fund, who have long realized the value of sustainable earnings acceleration as an important indicator of companies whose stock prices are likely to outperform. The focus is on identifying inflection points in companies’ fundamentals, because the market is typically slow to identify such points. As earnings growth accelerates, market expectations rise and valuations can expand.
A recent example is Intesa Sanpaolo, the Italian-based banking and financial services company. The company is benefitting from the improved macro environment in Italy, where lending growth is improving. This is leading to an inflection in company fundamentals – loan growth is improving and a fall in provisions for bad loans means that earnings growth is accelerating. Intesa Sanpaolo is not a traditional growth stock, but this improvement in fundamentals is leading to an acceleration in earnings growth. ACI believes this improvement has been under-estimated by the market, which will allow Intesa Sanpaolo to outperform as its ‘growth’ improvement is recognized.
Interestingly, this process has yielded a strategy that has been more resilient through-cycle, outperforming the benchmark even during periods when a more traditional ‘growth’ style has lagged.
For more information about Zurich’s Global Growth Share Fund please contact the Zurich Investments team at Zurich.investments@zurich.com.au
Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated January 2016, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance. GINN FVHHKJ.00012.ME.036. CSTT – 011088-2016
