With global indices dominated by expensive looking megacap tech stocks, where can investors find value?
Ben Arnold, investment director in the Schroder global value team
While market moves have been dominated by a small group of US tech stocks, the cheapest end of the market has seen a quiet revolution over the past couple of years. The view that value represents a one-way bet on banks and energy is well out of date and, by our reckoning, the opportunity set among the cheapest 20 per cent of the global stock market has never been more diverse.
Consumer-facing businesses have de-rated as the market fears the impact of a slowdown in growth. For instance, we have recently added Swatch (CH:UHR), the Swiss watchmaker, as its shares have been weak and we think the valuation is compelling, given the company’s strong balance sheet and track record of profit generation.
Elsewhere, those with a cyclical bent also look attractive. After a strong first quarter, commodity and materials-related names have been weak in 2023, and Anglo American (AAL) and BASF (DE:BAS), the German chemicals business, both look attractive on a medium-term view.
A key focus for us is assessing balance sheet strength. Many businesses we own are facing some kind of structural threat. When you couple this with too much leverage, especially given the rate environment, it’s a potent mix. We want to own businesses that are cheap, but have robust balance sheets that can be relied on to weather the storm. We will take balance sheet risk, but must be judicious and want to be paying pennies in the pound for [companies] where the potential reward is significant.
Europe
Of the three big European equity themes of recent times (LVMH/luxury goods, Novo Nordisk and ASML), which offers the most potential next year?
Robert Schramm-Fuchs, European equity manager at Janus Henderson
All three are exceptional companies and long-term winners, but that does not make them great investments every year.
LVMH’s (FR:LVMH) 2023 share price performance to date has trailed the other two stocks significantly. The company’s brands continue to gain share in a structurally attractive industry. Yet, we expect the stock to lag in the coming months given likely further industry-wide deterioration in overall demand in the fourth quarter, as well as a likely difficult start to 2024 given a challenging comparative growth base from H1 2023.
Following hefty price increases over the past few years, luxury goods pricing seems on hold, which means an important growth driver is falling away. The geographic mix risk profile is increasing due to an even higher dependence on Chinese nationals, which now make up more than 100 per cent of LVMH’s fashion and leather goods division growth. High-frequency data suggest weakening Chinese consumption trends. Historically, luxury stock share price relative performance only troughed when organic revenue growth bottomed out, which may not happen before Q2 2024.
So should one bet on the 2023 winner Novo Nordisk (DK:NOVO.B) to take the crown again next year? Demand versus supply for obesity care is dramatically out-of-kilter and will remain so for several years. Novo Nordisk has half a million patients on Wegovy at present versus 50mn US obese people under health insurance coverage.
There is a risk that access will tighten in the US from existing levels, and that some employers may opt to put time limits on the periods of coverage. Competition is increasing, too, with a number of alternative products in later stages of development and the chief rival product expected to be commercially launched over the course of 2024. While market share may not matter to estimates for the foreseeable future, eventually the stock market may struggle with the long-term assumptions.
We think ASML (NL:ASML) offers the most potential. Having troughed in April 2023, the semiconductor industry is now in the early stages of a new cycle upswing, and these tend to last two-and-a-half years. As per Q3 2023, ASML’s book-to-bill ratio had fallen to historical trough levels which in the past had signalled the most outstanding buying opportunities.
Doubts had been cast by some stock market participants on the pace of transition to the next most advanced semiconductor manufacturing node, which in turn drives growth opportunities for ASML, but that has now clearly been refuted by some of the leading chip companies. Another hit had come from the US export sanctions on China semi equipment sales, but that has also been well digested now. Finally, a new chief executive has been appointed, and he has the most excellent credentials from his long-time crucial role in key ASML technology development.
Asia
Outside of India/China, where are the most exciting opportunities in Asia next year, and why?
David Smith, senior investment director for Asian equities at Abrdn:
The Association of South East Nations (Asean) continues to look attractive. We see the bloc as among the key beneficiaries of the shifts in global supply chains amid the evolving geopolitical dynamics, especially between China and the US. The bloc’s supportive policies, cost competitiveness, industrial development, linkages to existing manufacturing hubs and rising middle-income consumers are structural drivers that should keep attracting foreign direct investments in the decades to come, and in turn boosting economic growth.
We like sectors that are exposed to the commodities market, but with a longer-term tailwind such as electrification. Being low-cost production centres globally, Asean countries are well placed to attract more foreign direct investments in the building of supply chains in electric vehicles and energy storage.
Across the bloc, a good example would be Indonesia, and a recent trip there by our fund managers brought to life again how the country is shaping up for the future.
The market continues to seek innovative ways to stay globally competitive, while also leveraging domestic potential. Family run/owned businesses are also looking at ways to address ESG concerns more, and it is important for us as investors, particularly in a low liquidity market such as Indonesia, to ensure that these conversations are constantly had to ensure our capital is responsibly allocated.
While concerns about discretionary spend remain at the forefront of many investors’ minds globally, it was heartening to see that Indonesia’s resilience here is also backed by tailwinds from favourable demographic trends, a characteristic that might not be so readily found in other more developed parts of the world amid rising cost inflation.
Other positives for Indonesia include policy, specifically the government’s focus on building out the electric vehicle ecosystem, particularly in the processing of nickel, with nickel downstream products now making up about 12 per cent of the domestic economy. Global battery manufacturers such as CATL (CN:300750) and electric vehicle automakers have also partnered with Indonesian mining groups to secure a part of the battery supply chain.
In short, Indonesia is undergoing a transformation, and if proved to be successful, this would mean that its economy will move towards more sustainable and higher quality gross domestic product (GDP) growth.
Emerging markets
Does emerging market outperformance next year require a weaker dollar? If not , what might drive outperformance?
Sorin Pirau, emerging market debt hard currency manager at Janus Henderson
In our view, the emerging market (EM) debt hard currency asset class represents a potential bright spot among EM risk assets. If you believe, as we do, that the US Federal Reserve is now at terminal rates, then US Treasury yields should be a supportive tailwind, and lead to a sideways or weakening US dollar.
Nevertheless, for hard currency emerging market debt (EMD), the US dollar has a much more limited impact on credit fundamentals than in the past because many of the large emerging market countries mainly finance themselves domestically in their local currency.
The direction of the dollar does tend to correlate to the performance of emerging market credit spreads: typically, 80 per cent of the time when the dollar strengthens spreads widen. Moreover, from a technical perspective, if the dollar cycle turns, we should see increasing allocations into EM assets given the negative correlation between US dollar and EM capital flows.
However, it is not the dollar movement that directly drives EM spreads, but the underlying drivers of the dollar that matter like the EM-DM growth differential (ie the growth alpha) relative to global financial conditions. Therefore, it is not a prerequisite to have a weaker dollar for EM debt to perform. We expect the recovery in growth alpha to be sustained in 2024 as well, and credit fundamentals to hold up going into next year on the back of positive policy adjustments experienced in some of the large EMs. Finally, today’s high single-digit yields provide a decent buffer against potential spread widening if things turn out worse.
UK equity income
What are the prospects for UK small and mid-cap dividend growth in the next year or so? How do they compare to larger companies?
UK small and mid-cap dividends are underpinned by earnings growth well ahead of FTSE 100 peers'. Taking consensus data, stocks outside the FTSE 100 index are due to deliver dividend growth for the year to December 2024 in excess of 11 per cent. But large-cap dividends are due to grow less than 7 per cent.
The reason why smaller companies can deliver this superior growth has to do with their underlying earnings profile. According to consensus data, FTSE Small Cap and FTSE Aim indices are due to deliver compound earnings growth for the three years to 2025 of 18 per cent.
This growth profile is comparable to the US Nasdaq index, yet these UK-based indices trade at less than half the equivalent forecast earnings valuation multiple. This presents investors with potentially significant returns as the valuation gap that currently exists compresses as the cycle turns.
If economic conditions toughen, smaller companies have the ability to be more nimble, enabling these businesses to better deliver expected returns and dividends than more weighty companies further up the market-cap scale. Smaller company dividends are further protected due to the far superior dividend cover on offer across many of these stocks compared with larger names.
And in many cases, this cover remains above pre-pandemic levels. So there is scope for these companies to grow dividends well in excess of the already attractive earnings growth expectations – as and when economic conditions allow.
We suggest that from a stock valuation, and dividend growth and cover perspective, UK small and mid-caps are a compelling opportunity.
