It is probably true that as a fund manager one has a natural wish to forecast a rise in the stock ma...
It is probably true that as a fund manager one has a natural wish to forecast a rise in the stock market. Fee income falls when the value of the fund falls and the manager gets grief from the marketing department for making gloomy predictions, as subscriptions will be impossible to garner. Consequently, if in doubt about the outlook for the forthcoming year, most managers predict a rise of 0% to 10%.
The advantage of this approach is that markets usually rise, especially when there is universal nervousness. This is the situation now, as shares are both cheap and there is a lot of 'angst'. Some pension funds in Europe have reduced equities to residual levels and insurance companies are light as well. Only Americans are buying systematically. Shares are cheap as the index is back to 1998 levels on concerns over consumer debt, which, especially in the US, has resulted in a non-sustainable economic boom.
It is unlikely that interest rates will rise much. We have just had a huge boom in commodities, combined with strong world economic growth and still inflation is subdued. Without a big rise in interest rates, why will world economic growth suddenly halt? Life is tough for many companies, but it is because of this and that so few have pricing power (the ability to put up their prices at will, as they did in the 1970s) that inflation is subdued. Corporate profits are growing slowly, but in absolute terms they are very high.
Management behaviour towards shareholders makes us positive. We are still five to 10 years behind North America but over the past few years there has been an improvement. Even very low-growth businesses are producing excellent shareholder returns. Earnings growth can come from using strong cash flow to pay down high debt levels (we have made money in Zurich Airport and the electricity utility RWE) or more commonly from share buy backs. In a low interest rate environment, companies are borrowing to buy back a large amount of their shares for cancellation without damaging their balance sheets.
Some management teams are still in the old ways. They talk about being shareholder friendly but their real aim is to increase the size of their company. But this is becoming a dangerous strategy following the shareholder inspired management departures at Deutsche Boerse. Its bid for the London Stock Exchange failed after it became apparent that virtually everyone was benefiting from the bid except Deutsche Boerse shareholders.
Finally we note that the estimated yield for this year on the European market is 3.0%, close to the Euro zone bond yield of 3.2%. The gap is the narrowest it has been in 50 years, apart from the March 2003 trough of 0.1% (when equity yields had risen sharply, rather than the current position of bond yields having collapsed). With dividend cover good and rising, we feel this is another support for markets.
European inflation should be subdued despite a commodities boom.
The management of many European companies is improving.
However, it is vital to avoid companies that are stuck in their old ways.
Paul Bruns and Elaine Parkes
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