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How star growth managers are coping with the recent value rotation

21 February 2017

Nigel Thomas, James Thomson and Colin Morton, give their thoughts on current market conditions and why growth stocks are still necessary despite last year’s violent market rotation.

By Lauren Mason,

Senior reporter, FE Trustnet

A sudden boost to market sentiment caused by fiscal policy expectation has led to some high-quality growth stocks trailing in the dust, but a number of managers warn there are still plenty of risks for investors on the horizon.

AXA IM’s Nigel Thomas, Rathbone’s James Thomson and Franklin Templeton’s Colin Morton believe that, in many cases, the more defensive and expensive stocks will actually offer investors the greatest opportunities in 2017.

This is despite the fact many investors believe that fiscal expansion – one of US president Donald Trump’s proposed policies – will spell good news for markets as economies strengthen and are therefore using today’s market conditions as an opportunity to buy into cyclically-driven stocks trading on attractive valuations.

Performance of indices over 1yr

 

Source: FE Analytics

Not only this, there are widespread concerns that fiscal loosening will boost inflation, which would then eat into the yields of ‘steady Eddie’ stocks that have long been used as income streams for the cautious investor.

FE Alpha Manager James Thomson (pictured), who runs the £926m Rathbone Global Opportunities fund, believes developed markets are already due to change direction once more, despite the value/growth rotation only occurring during the last financial quarter.

“The stock market is hypersensitive to economic data and the business-friendly freebies dangled by President Donald Trump. But Trump-mania is likely to fade as the watered-down realities of budget negotiations become apparent,” he warned.

“We think equities could correct soon, but the main feature would be a change in market leadership. In fact, a rotation out of the ‘value’ reflationary plays into more reliable ‘growth’ stocks has already begun.”

The manager says he is often asked about the high valuation of equities seen across developed markets at the moment, given that most indices trading at between a 10 and 20 per cent premium relative to their 10-year average.

Thomson says this suggests that markets are expecting improving economic data to drive earnings upgrades. As such, and contrary to market expectations, he says value stocks look the most vulnerable, as valuations are now at 40-year highs and dependent on a reflationary boom bail-out.

“If the economic data starts to fade and the earnings impact of the Trump policy agenda gets diluted, then the medium-term outperformance of growth stocks would intensify,” he added.

In the UK, FE Alpha Manager Colin Morton – lead manager of the five crown-rated Franklin UK Rising Dividends fund – says there are numerous “known unknowns” on the horizon, such as the impact a hard Brexit will have and the geopolitical uncertainty across Europe.


“Here in the UK, the outlook remains uncertain as the government embarks on its Brexit negotiations,” he said.

“That uncertainty, and in particular fears of a ‘hard Brexit’ in which the United Kingdom fails to secure any trade agreement with the European Union, has maintained the pressure on sterling.

“However, we think the spotlight has been diverted from what really matters—sustainable growth in particular UK sectors.

Performance of currency vs US dollar over 1yr

 

Source: FE Analytics

“The weaker pound has contributed to a higher-than-expected rise in UK inflation, and investors may be wary that this could impact dividend yields. In a rising-rate environment, we have to acknowledge inflation will eat away some of that yield.”

However, Morton sees the best opportunities in defensive stocks which aren’t correlated with the economy, particularly utility stocks that supply water and electricity.

Despite admitting that they are heavily regulated, the manager says regulators allow them to raise prices in line with inflation when demand wanes, which means they are more resilient than many investors may realise.

“We place our emphasis on good quality companies where we feel dividends are likely to remain more sustainable in the event of unexpected shocks,” he continued.

“The weaker pound may actually have a positive impact on UK-listed dividend payers, at least for the proportion of FTSE 100 companies that declare dividends in US dollars. The weaker sterling gets, the stronger dollar-based dividends become.

“In the wake of the Brexit referendum last year, focus fell on UK industrial and manufacturing stocks. These stocks were hit hard, but they recovered equally as quickly. At the moment, we still remain cautious of banking and energy stocks, namely over concerns of yield sustainability.”

Nigel Thomas, manager of the AXA Framlington UK Select Opportunities fund, is also focusing on the potential repercussions from Brexit and has been quizzing every company he is invested in about their long-term investment plans.

While he says most of these haven’t changed their tack at all, he warns that this might not be the case over the longer term depending on whether a ‘hard’ or ‘soft’ Brexit is agreed.


“We also remain in something of a geopolitical limbo with upcoming European elections, but that is the world we live in and there will always be an element of uncertainty,” the manager explained.

“What’s important is to focus on the fundamentals, keep calm and carry on.  We have to talk to businesses, look at and assess their plans, help them acquire businesses with capital in order to enhance their total shareholder returns.”

Given the high levels of market volatility experienced last year, Thomas says it is now more prudent than ever to focus on secular trends that aren’t dependant on geopolitical events.

Performance of index in 2016

 

Source: FE Analytics

“Fundamentally, there is a lot of noise in the stock market so our ethos is to stick to good quality companies, that can grow revenues, earnings and ultimately their dividends – they can generate cash,” he continued.

“We have a high quality threshold in the investments that we make – we stick to that, whatever the market throws at us, rather than bow to the whim of political changes or currency fluctuations.

“In 2017 we’d like some stability, but that looks like wishful thinking. We expect to see the trend for mergers and acquisitions continue because, in a low growth world, to acquire businesses is one way to increase your revenues and thereby enhance your earnings.”

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