In the past few years, we have had more than enough excitement in equity markets to last for a while, with high-riding bull markets that were then savaged by the bears. It is now a good time to consign greed and fear to the background for a while and focus instead on boring.
All those good old-fashioned, reliable and, yes, boring companies that are well capitalised and selling goods or services that people actually need are the ones most likely to perform well for their shareholders. They will be sought after by astute investors in the coming years – and many are currently underappreciated and consequently undervalued.
Companies that are well capitalised but have goods or services of doubtful medium-term relevance, or are undercapitalised even though they sell relevant products, are unlikely to be good investments. Both characteristics are needed. A lot of companies are making good products that currently have a market, but that still have a worrying amount of debt to service.
The return of capital to markets in the past year rewarded many companies simply for surviving. This trade is now over, and with stimulus packages starting to be withdrawn, it is time to look for those companies that can stand up by themselves.
Even in international equities, the focus should be on finding good companies, not making bets on regions. Country location is only one of the many factors that should be considered. It might seem counter-intuitive because of the widely-reported economic problems in Europe and the United States, but there are many companies in these areas that have very attractive fundamentals. These include an entrenched customer base with high barriers to entry and significant management depth.
In contrast, emerging markets have a significant number of companies currently regarded as exciting opportunities but which do not meet the criteria of good governance and strong capitalisation combined with necessary products or services.
Many large companies in developed markets earn a large and growing portion of income from emerging markets and many companies in emerging markets generate sales from developed markets. Investors should be careful of what they are buying – it’s not as simple as where the company is listed; where they sell should also be taken into account.
So despite the negativity, the US, United Kingdom and Europe remain well-diversified economies with diverse consumer and corporate sectors – quite simply, they are too big, too diversified and too well supported to fail. There is a much more attractive risk/return trade-off in larger economies relative to other markets. In fact, emerging markets are no longer cheap or benefiting from loose monetary policy.
Valuation is going to be the key for sound investment decisions – getting more value than you pay for will always result in dividends for any investor.
This means stock selection is going to be of even greater importance for investors both domestically and internationally.
But it’s not going to be easy, for the economic pain hasn’t been fully felt yet, despite the recent equity market snapbacks.
As a result, for the rest of this year and into next, it will be ability, experience and strength of investment process that will reward fund managers and their investors.
