One year later, with Nathan Lim from Australian Ethical

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We remain positive on the US as the extended recovery takes hold. Full-time job growth and modest wage inflation are good signs as is the resilience of the services sector as seen in the non-manufacturing index from the Institute for Supply Management. Last year we were concerned with high market multiples, and while they have gone higher, negative earnings revisions have long reversed and are still in a rising trend. This shows profit growth expectations are at least rising which is consistent with rising multiples. We still like Covanta and see next year as an inflection point for cash flow generation as new contracts ramp-up and more metal is recycled from the waste stream.

Looking at Europe, market multiples have also risen to new highs but earnings expectations are trending down. In conjunction with our indicators that are only mildly positive, we are not as bullish on Europe as we were this time last year. The conflict in the Ukraine and Greek debt talks have weighed on sentiment. Likewise, we believe the slowdown in China is finally starting to manifest in this region as well. We are currently underweight in Europe but are selective buyers of quality names. For example, we continue to like Gamesa as they are carving out a strong market position as the defacto partner for wind energy development in the emerging markets. At this time, we generally believe the desire for governments to decarbonise their power sector remains stronger than any potential macroeconomic slowdown.

We are very cautious on the outlook for China. Our macroeconomic indicators have been in a steady decline since last year. The recent breakdown in the Purchasing Manager’s Index for manufacturing and falling shipping container traffic is particularly worrisome. China's economy looks to be stalling which naturally has serious ramification for global trade. Recall China is the world’s largest trading nation with annual two-way trade with the world in excess of US$4 trillion or equivalent to about 6% of global GDP. Given the tepid recovery in most countries, weak demand from a major trading partner would be the sort of negative shock that could arrest a recovery. So far the deceleration in the Chinese economy has been largely orderly so we remain optimistic that China will manage a soft landing for its economy. Since last year, we did re-enter the Chinese market via stakes in Goldwind and JA Solar.  The buildout of renewable energy in China supports both companies, and each has reported impressive financial results in turn. China continues to pursue a robust green agenda, and we believe both are in a prime position to benefit from the buildout of wind and solar power.

Our macroeconomic indicators show a decelerating Japan. They appear to be the biggest casualty of a slowing China at this point. Our indicators are broadly neutral with a downside bias. For example, air cargo traffic, which we find to be highly sensitive to economic conditions, has turned negative for both import and export cargo traffic. Over the past 12 months, fortunately, our selected Japanese stocks have performed very well as stock-specific factors like increasingly stringent vehicle emission standards drove share price returns (NGK Insulator). Also, our ample exposure to exporters benefitted from the country’s weak yen policy (Denso, Shimano).

To summarise, we are weary of the Chinese slowdown. We believe Europe and Japan are already feeling the effects of it but more so for Japan. The US looks well positioned to weather slower growth in China, but would be just as vulnerable as the rest of the world if China fell into a recession. To be clear, China’s slowdown still appears to be well managed, so we are not calling for a more pronounced slump. We remain selective buyers of quality and those most positively exposed to emissions reduction and energy efficiency.

 


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