The UK market has rallied strongly from the lows of mid-March, led by cyclical mid and small-cap st...
The UK market has rallied strongly from the lows of mid-March, led by cyclical mid and small-cap stocks, but we believe subdued global growth could persist for some years.
This is due to overcapacity in many industries holding back corporate investment and high US and UK debt, which has been restricting the ability of the consumer to respond to the stimulus of even lower interest rates. As a result, expectations of a rapid economic and profit recovery may not be met.
Many companies reporting this year have achieved earnings growth through cost savings, paying down debt or share buybacks.
BT is a good example. Its forecasted profit growth arises from cost reduction, smaller losses within subsidiary firm Ignite and a lower interest bill. Revenue growth for BT is virtually non-existent. For most companies, an eventual resumption of turnover growth will be required to drive profits and share prices higher.
Another negative for the UK market is the persistent high valuation of US companies. If this holds US stocks back, the UK may find it difficult to make progress.
On the positive side, however, debt is currently cheap. For venture capitalists or corporates borrowing at a rate of 5%, there is an immediate cashflow benefit in buying companies with free cashflow yields of 9%-10%.
Further takeover activity, especially involving a FTSE 100 stock, would lead the overall market higher.
There is also the possibility that one quarter of US growth could be unexpectedly rapid because of a build-up in inventory levels. Some economists could mistakenly extrapolate this as a longer-term trend, propelling cyclical stocks higher.
However, if the central assumption of single-digit returns is correct, it will be important to identify sectors that can thrive in a low growth, low inflation world.
One theme identified by Newton is the rapid growth of trade into and out of China. Transport companies such as P&O and Exel will benefit from this long-term trend.
Likewise, the increasing use of financial products by Asian consumers provides banks such as HSBC and Standard Chartered with a degree of long-term growth not available to UK domestic banks.
Another long-term theme is that of mobility and the global trend towards using mobile technology. A company like Vodafone is a massive beneficiary of this.
In addition, for stock-specific reasons, namely the potential to improve margins by integrating back office functions, Vodafone has every chance of beating profit forecasts. On a 2004 P/E ratio of 12.5 times, the stock has never been cheaper and is likely to offer absolute share price upside even if the market is flat.
A combination of identifying a long-term thematic trend alongside detailed company-specific analysis should highlight stocks to be held in an outperforming portfolio.
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