We expect the macro environment in the next decade to be characterised by low inflation, low economic growth and thus very low interest rates. This ‘Japanification' scenario will have profound implications for equities. It will certainly prove a risky environment, but if history is any guide, it should also offer excellent opportunities.
In such a scenario, two investment styles should particularly thrive. The first is quality growth, as companies that are able to grow, irrespective of the economic environment, should experience a rise in the price-to-earnings ratio due to their scarcity. The other is equity income, not only because of their superior dividend yield but also because those companies tend to offer superior risk rewards in difficult market environments.
‘Japanification' does not mean that economic cycles will disappear, only that they should become more muted than in the past. That is precisely our scenario for 2020, where we expect a small uptick in growth. This in turn implies better performance from economically sensitive sectors, after years of underperformance.
It ,therefore, appears reasonable to include some opportunistic cyclical exposure to portfolios. This could be achieved in particular through some well-run industrials and consumer discretionary companies, whose depressed historical valuations leave ample room for a re-rating if economic sentiment improves in 2020.
Nevertheless, the core of all portfolios should remain centred around high quality companies that can grow regardless of the macroeconomic environment. We try to identify stocks that enjoy pricing power in industries with high barriers to entry to reduce the risk of disruption. This is of paramount importance, as technology, globalization and easy access to capital have dramatically increased the challenge that companies face. Every industry is potentially impacted, from healthcare to consumer brands and financial services. Investors need to scrutinize their portfolios more than ever to avoid losses.
Embrace natural compounders
We continue to favour technology companies as they are amongst the main beneficiaries of this transforming competitive landscape. Some of these companies are structural winners and we intend to remain invested in the long term. These firms are natural compounders that should be kept as core equities in the portfolio. As they happen to be mainly located in the US, we are also overweight that region.
Operating margins of US IT sector versus US Industrials ... a premium is justified
We also like dividend payers, as long as they do not sacrifice their growth and investments to pay excessive yields. Those companies tend to be more disciplined than their non-paying peers, which translates into better risk return characteristics in the long term. In a world of ultra-low rates, they also provide a valuable source of income.
Dividend equities are cheap …
SYZ AM, BLOOMBERG, NED DAVIS. Data as of end of October 2019.
2020 will be paved with geopolitical risks: US elections, Hong Kong unrest and Brexit uncertainty to name a few. But thanks to a more benign economic environment, reaccelerating earnings and still accommodative central banks, we expect equity markets to provide another year of positive performances.
Roberto Magnatantini, head of global equities at SYZ Asset Management, and Saïd Tazi, senior portfolio manager at SYZ Private Banking