History never quite repeats itself but it often rhymes, so it is probably best to ignore the backwar...
History never quite repeats itself but it often rhymes, so it is probably best to ignore the backward-looking pundits ' the bulls who say we won't have a fourth successive down year in equities because it has little historical precedent and the bears who argue we will because we are following the patterns of Japan in 1990 and the US in 1929.
It is more enlightening to look at the fundamentals, which indicate basing investment strategy on market direction is unlikely to be as rewarding as doing the hard slog of stock selection.
Despite the general sluggishness, the eurozone will still have managed nearly 1% growth, with the US and UK growing even more. After so many years of increasing prosperity, that may feel like a recession but history will certainly not see it that way. The ECB will support growth by further reducing rates in 2003, and maybe even relaxing its inflation target, but we still expect growth this year to be similar to 2002.
The euro did strengthen late last year and it should strengthen further due to the eurozone's substantial trade surplus, which compares favourably with deficits in the US and UK. A stronger currency is clearly bad for Europe's export companies but the benefits are that it reduces import prices, depressing inflation and boosting consumers' disposable incomes while making it easier for the ECB to cut interest rates.
With inflation staying in low single digits, nominal growth (real growth plus inflation) could be around 4%-5%, a level that makes it very tough for companies to generate the sales growth to drive profits. This contrasts with the market consensus of earnings growth in the mid-teens in 2003. We believe single digit is more realistic.
There have been long periods in which markets have not moved much despite short-term volatility. In such markets, stock selection has always held the key to generating decent returns.
Thematically, after the stagflation of the 70s and disinflation of the 80s and 90s, the new investment theme will be the Ice Age. This is our term for an environment of slow growth, low inflation and low interest rates.
The best investments will have quite the opposite characteristics of those that did well in the previous two decades. In the 1990s, companies needed leverage, used for acquisitions, to boost growth rates.
But in a low inflation, low growth world, this strategy is dangerous because acquisitions cannot easily appreciate, while real debt burdens remain stubbornly high. Returns will come from stocks with strong cashflows, sound balance sheets and market leadership positions that confer a degree of pricing power.
Some companies have a sound franchise but a cost base that became bloated in the good times. These firms' profits can grow without rising sales.
We are indeed entering a new era of investment but one that will be similar to many previous periods of low growth and inflation. The Ice Age theme will shift the investment emphasis from market direction to stock selection and from momentum to fundamental analysis. In a world of very low interest rates, good stock selection should still be able to generate meaningful returns for investors.
Inflation in low single digits.
Further ECB rate cuts likely.
Eurozone growth despite sluggishness.
DB and a lack of alignment
Encouraging better use of tech
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