Wonderful companies at depressed valuations
As Trump pressured China with trade wars, manufacturing indices around the world showed steady declines. I attribute this to falling business confidence, leading to weaker orders by businesses around the world.
However, consumer spending in most markets around the world is holding up quite well and consumption is the biggest driver of gross domestic product (GDP). So, while we are seeing a deceleration in global growth, economies and businesses are still growing.
The big sell off in consumer related stocks, whether it be a consumer goods manufacturer (Whirlpool) or a retail bank (Bank of America (NYSE:BAC)) in the US or an ecommerce company in China (Alibaba (NYSE:BABA)), is actually a buying opportunity as you can now buy these wonderful companies at depressed valuations.
The big driver of GDP
We are watching the decline in the purchasing managers’ index (PMIs) closely to see the extent of the manufacturing slowdown, but don’t forget that this only reflects a portion of GDP.
Chart 1: PMIs are dropping but they are still above 50 which reflects growth
The bigger driver is the consumer and I often find that the best read on the health of the consumer in an economy is the large banks that lend out to these consumers, small and medium-sized enterprises (SMEs) and corporates.
Chart 2: US retail sales are still seeing healthy growth
JP Morgan and Bank of America recently reported their results for the December quarter and they were actually quite healthy. Bank of America reported 5% loan growth in their consumer banking division and revenue growth of 10%. More importantly the credit quality of their customers continues to improve, reflected in their net charge-off ratio which declined to 0.39% from 0.53%. These results reflect a healthy economy with unemployment at a very low 3.9% and GDP probably growing in the range of 2%. In December non-farm payrolls showed a very strong job hiring number of 312,000 with average hourly earnings up 3.2% in the US.
The falling share prices of these economically sensitive businesses is not due to fundamentals and just as quickly as we have seen the prices of banks around the world fall, as they did in 2016 during Brexit, we could see these economically sensitive stocks rebound very quickly. I think Marianne Lake, the chief financial officer of JP Morgan (NYSE:JPM) summarised the current situation quite succinctly saying;
“We think the outlook for growth in the economy is still strong, the consumer is still strong and healthy and we’re expecting to still see maybe slower but still global growth going forward”.
Europe a casualty of trade wars
I think the affect of the trade wars are having a bigger impact in Europe coupled with the fragile political situation. Europe’s composite PMIs declined to 51.1 and this impacts manufacturing heavy economies like Germany quite significantly.
Consumption in France also seems to be weakening following riots by “gilets jaunes” or “yellow vests” in Paris in December, reflecting discontentment around their government.
While the UK economy seems to be holding up, the political situation is a joke as clearly there is a strong force trying to over-turn Brexit.
How we’re positioned
Given that we are late in the economic cycle, we have increased our exposure to defensive consumer franchises with 21% of our portfolio exposed to food and beverage staples that do well in a weaker economy. We have 14% in structural online winners and still own some more economically sensitive businesses like banks, which are currently pricing in a recession, but we think that is a few years away.
Happy hunting and shopping!
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