The last decade was one of steady recovery from the GFC for the world, but also one of great uncertainty and political instability. Markets had the Euro crisis, US debt ceilings, Brexit and a US-China trade war to deal with amongst other issues. Central Banks were trying hard to provide support to the market and the economy through this period by cutting rates aggressively and introducing unconventional monetary policy tools. This helped to extend the bond market rally into its third decade and drive yields around the world to record lows and many into negative territory. The market was also confident enough in the commitment of central banks to provide policy support that they priced bond yields well below the rate of inflation in many markets, including Australia. This collapse in real interest rates saw a rational, but massive expansion in equity market multiples. This was particularly so for parts of the market that could offer genuine growth, certainty in earnings or a secure dividend yield.
It’s unlikely given that unemployment is now below pre-GFC levels in most major economies including the US, the EU and Japan. It could certainly persist for another year though. Inflation has remained quiescent, although not as weak as some may presume, which should provide markets with confidence that central banks will remain committed to supportive policies. This Goldilocks scenario of growth being neither too hot nor too cold may be a difficult line for the market to tread in 2020, but it’s also unclear what will shift the market significantly in either direction.
In a status quo scenario where global growth is reasonable, but unexciting and bond yields remain near record lows then the best performing stock is likely to be one where investor perceptions shift. A company where expectations lift around its long term growth potential will do well and we think that Corporate Travel Management could be such a stock. Corporate Travel has been a strong performer, delivering significant growth over the last decade, but has de-rated over the last year. This was driven by concerns over its acquisition strategy and free cash flow generation. Since then the company has demonstrated a continued ability to generate both organic growth and strong free cash generation despite seasonal variation. The company has a widely acclaimed product offering, continues to take market share, has a strong balance sheet driving high return on invested capital and plenty of opportunity for organic growth and further acquisitions on a global scale. The quality of the business is demonstrated by its ability to deliver solid earnings growth this year despite some macro headwinds in international markets from protest disruption in Hong Kong and Brexit uncertainty in the UK and Europe.
There is also the potential for growth to surprise on the upside. Global activity appears to be stabilising as the manufacturing cycle bottoms out, aided by recent rate cuts. A stabilisation in global auto sales, solid consumption spending and stronger commodity prices are starting to support activity and inventory destocking is ending. A stronger growth environment would generally be positive for the earnings outlook and supportive of equities, but even a small tick up in inflation expectations could see bond yields higher and the valuation multiples of many companies coming under pressure. A stock that we like in this environment is Bluescope Steel. Bluescope has leverage to stronger growth through steel spreads as well better volumes in the US and Australia. There is also the potential for growth through the planned expansion of its high margin North Star operation in the US. While the stock has rebounded from recent lows, a net cash balance sheet and a strong focus on cost efficiency in recent years provides it with resilience in a softer economy as well.
A scenario where growth slips to the downside could also prove problematic for the equity market where earnings expectations are relatively high. While we would undoubtedly see more support from central banks, some unconventional policy tools and more negative bond yields, equities may be weighed down by earnings risk over multiple expansion. Risks on this front are varied but could include a resumption of the US-China trade war or an escalation in the current tensions between the US and Iran. This is an environment where we favour gold, which would benefit from further central bank stimulus and general uncertainty in markets. Australian gold equities have broadly underperformed the gold price in the last few months and present an attractive entry point. One of our favourite stocks is Saracen Gold, which as well as the strong performance of its Thunderbox mine has recently acquired half of the Kalgoorlie Super Pit along with Northern Star. This provides a strong reserve base and extends mine life as well as providing the opportunity to ramp up gold production as the east pit wall collapse is remediated.
While the status quo of moderate growth and easy liquidity conditions is likely to continue through 2020 and support another year of strong asset price growth, the risks are becoming more finely balanced. Having some style diversification and exposure to stocks that will do well if the market is jolted out of the Goldilocks zone is definitely worthwhile.
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