The global economy is likely to disappoint as president Donald Trump’s promises of growth seem less likely, warned Rathbone Investment Management’s James Thomson (pictured), who said investors may have become too ‘gung-ho’ as they rotated out of growth stocks into value plays at the end of last year. 
The FE Alpha Manager, who heads up the £1bn Rathbone Global Opportunities fund, also believes value stocks are teetering on dangerously high valuations relative to history, which could mean many investors will become unstuck if global growth slows and reflationary policy becomes diluted.
As such, he said growth stocks could continue to rise in popularity as we head through the year – particularly US technology companies – despite many investors believing they are currently too expensive.
This trend is already apparent year-to-date, with the FTSE World Growth index comfortably tripling its value counterpart with gains of 12.38 per cent.
Performance of indices in 2017
Source: FE Analytics
“This year growth is very much back in favour and value is deeply out of favour. Part of it is because some of the Trump policies have been diluted or are disappearing. Also, the return to growth that he has promised is also disappearing,” Thomson explained.
“So when the economy starts to disappoint, investors embrace growth and it’s counter-intuitive, actually. People think that in difficult economic times you don’t want to own growth stocks, but this is exactly the kind of stock you want to own. Because when growth is so hard to find, investors wrap their arms around growth stocks because that are actually delivering.
“That’s why you’ve seen such massive outperformance from these reliable and sustainable growth areas such as technology and consumer staples. They don’t care who is in the Oval Office, their growth is largely independent of White House policy. The success of Amazon and Facebook has nothing to do with Donald Trump.”
Instead, many of the stocks Thomson holds in his portfolio – such as the aforementioned Amazon and Facebook as well as Tencent, Visa and Adobe Systems – are powered by changing consumer behaviours, methods of communicating and the rise of e-commerce.
“The push-back I get is that valuations are too high. My comment is I think the value managers should be careful,” the manager warned.
His research shows that, in terms of US equities, value stocks are trading on an average P/E ratio of 20, which is a 40-year high. While US growth stocks are trading on a similar P/E ratio, this is not particularly high relative to history.
Source: Russell Investment Group, Jefferies, Rathbone Investment Management
“I would say the risk still lies in value stocks. You need an economic recovery to justify this 40-year high valuation. Growth stocks will have their own independent drivers that aren’t as closely-linked to the cycle,” Thomson continued.
“That’s why this fund is having a pretty good year. Year-to-date we’re up 13 per cent against an average of 7 so we’re clawing back some of the disappointing year we had last year, and it is precisely these companies – technology and consumer companies – that are really leading the charge.
“We’re fully invested, we have 60 holdings in the fund and my limit is 60. We’re chock full of ideas – we have a watch list bursting at the seams. These stocks are desperate to get a place in the fund but it’s now a matter of ‘one-out one-in’ to be able to do this.”
While value stocks are off the menu for Thomson because of his growth mandate, he said they would look more appealing if the economy was showing signs of a robust recovery. However, he doesn’t believe this will be the case and said economy growth could well disappoint.
“I think the drivers are in the rear-view mirror. If you wind the clock back 12 to 18 months, the oil price was rising, interest rates were rising – not only the federal funds rate but also the market interest rate was rising,” the manager explained.
“What that means is they were tightening conditions and there was tightening in the pipeline. But, it takes time to transmit that into the real economy.
“The tightening in the form of higher rates and higher commodity prices that we witnessed last year is going to start to bite now. That is the headwind the global economy faces this year.”
Thomson said the recent pullback in the growth/value rotation represents a “dawning of reality” among investors, as the market loses faith in Trump’s ability to deliver on many of the promises he made during the electoral campaign.
He also warned against investors believing these policies – even if some of them are implemented – are a panacea which will bolster global growth and place the economy on an upward trajectory.
“Lowering tax rates, offering a tax break on repatriating foreign earnings, it’s no silver bullet. It’s a stay of execution for some companies, but ultimately you want companies that can survive through a variety of different economic environments and policy changes,” he said.
“Those are the strong companies you really want to embrace because, as soon as that tax cut happens, that’s the end. That freebie will have been given.
“I think the idea that we’re going to get back to 3 per cent economic growth is a fantasy. We’ll be living with what we lived with before which is below-trend, slightly disappointing economic growth and investors scrabbling round trying to find it.
“Usually when that’s the case, they scrabble around in my world because I own companies that are delivering growth in a low-growth world. They happen to be the most exciting companies in the world.”
Thomson’s Rathbone Global Opportunities fund has achieved top-quartile returns over three, five and 10 years. While it is in the second-quartile over the last 12 months due to last year’s sharp rotation into value, it has still outperformed its average peer over this time frame.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
The fund has a clean ongoing charges figure (OCF) of 0.79 per cent.