“The dovish Fed and trade truce have caused investors to reduce cash and add risk,” said Michael Hartnett, BoAML’s chief investment strategist, “but their expectations of an earnings recession and debt deflation still dominate sentiment. The pain trade for the summer remains up in stocks and yields.”
Mark Haefele, global chief investment officer of Swiss investment bank UBS, doesn’t expect the performance of equity markets to be knocked off course imminently. This is despite expectations of a disappointing Q2 US company earnings season. Many financial companies report this week and their potential profit growth is already hampered by the pause in interest rate hikes.
Technology and industrial companies could show signs of an adverse reaction to the US-China trade dispute but, across all sectors, UBS still expect average earnings growth of 5 per cent for US companies. Although President Donald Trump has warned there is still a long way to go in trade negotiations, Mr Haefele feels that along with the likelihood of the Fed cutting rates, any sustained thaw in relations with China will be positive for US equities: “Assuming a lasting trade truce between the US and China, we could see some revival in business capital spending. Consumer-oriented sectors, meanwhile, continue to benefit from high confidence and rising wages. We expect overall earnings growth to recover to seven per cent next year.”
UBS feels the outlook is weaker for eurozone equities and doesn’t expect profit growth this year, although that doesn’t necessarily mean there will be an earnings recession that ends the bull market. Preferred European sectors are utilities and energy.
Trouble-shooting for UK income investors
Societe Generale’s Cross Asset Research team screen FTSE 350 and FTSE All World stocks each month (the last edition was published on 3 July) and their quality income strategies have brought up some European energy companies too. Energy majors are cyclical and, to an extent, their share valuations are at the mercy of the oil price. Yet, these businesses have shown remarkable commitment to returning cash to shareholders. Regardless of whether their prices are volatile, if the companies are in good health, there is the argument steady income will be a boon to long-term investors in the next downturn.
Usefully, the SG screen is focused on the financial health of income stocks – it highlights companies (excluding financial stocks) with a prospective yield of over 4 per cent that are in the top 40 per cent of the universe by Merton’s distance-to-default measure and with a Piotroski score of 7 or more. The former metric expresses risk in terms of the likelihood of defaulting on bond payments and the latter is a checklist of financial performance and solvency ratios. No method is entirely fool-proof but companies that perform relatively well on both sets of criteria are less likely to disappoint.
The UK-listed oil majors aren’t represented in the top 25 listings from the SG Quality Income screen but companies that do score well are mining stocks BHP Group (BHP) and Rio Tinto (RIO). Of course, stock screen results aren’t the same as buy recommendations and it’s worth remembering both companies have been questioned over the long-term efficacy of buyback and dividend policies. Miners are also particularly exposed to any slowdown in Chinese demand, should fallout from the trade dispute with the US hit infrastructure spending.
Pharmaceutical giant GlaxoSmithKline (GSK) is the other UK income major highlighted by the quality income screen, which is interesting given its drugs pipeline makes GSK a company Investors Chronicle has an optimistic view on.
On the downside, SG’s separate high dividend risk screen – which highlights high yield companies that score poorly on the Merton measure – includes several UK listings, including construction firm Galliford Try (GFRD), utilities group Centrica (CNA), Royal Mail (RMG), oil & gas services companies Petrofac (PFC) and John Wood Group (WG.), Dixons Carphone (DC.), industrial firm Babcock (BAB) and fashion company Ted Baker (TED). Again, the usual caveats about stock screens apply, but avoiding balance sheet risk at a late stage in the economic cycle is one way to side step potential value traps that have the bait of a high dividend yield.
In Alpha:
One of the problems investors have is that investing in the sort of quality companies that will be resilient when there is a next downturn, has become something of a crowded trade. In this week’s AlphaScreen, the top rankers against Algy Hall’s quality methodology are in many cases quite expensive. Looking further down the list, at companies only failing one or two tests, may offer a better trade-off between quality and value at this stage in the cycle.
In this week's shares round-up, Phil Oakley will be discussing clothing retailers, drinks manufacturers AG Barr (BAG) and Nichols (NICL), motor aftercare business Lookers (LOOK), Finsbury Food Group (FIF) and confectioner Hotel Chocolat (HOTC). Last week's edition is still available here.
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