As investors came to work on September 15, 2008, we braced ourselves for the fallout from the news Lehman Brothers had filed the largest bankruptcy in history.
Expectedly, significant drawdowns and volatility in markets around the globe followed and, since then, the FTSE 100 and S&P 500 indices have returned nil, including dividends. That said, even with the added currency impact, the S&P 500 demonstrated much lower downside volatility compared to the FTSE 100. This highlights the US’s deserved role as a core investment region.
After the significant drawdowns in global markets, the past seven months have demonstrated consistency with history as the stock market has performed strongly alongside the recovery in economic activity and positive surprises from companies during the past two earnings seasons.
We remain positive on stocks despite moving towards the next stage whereby the economic recovery matures but with increasing uncertainty over its breadth, speed and smoothness.
The news about not getting worse is no longer sufficient; the markets will need to see evidence of improvement. Now markets have recovered from the post-Lehman trauma, we expect to see outsize returns accruing to companies meeting our investment criteria, rather than homogenous low-quality or small-size factors delivering top performance.
What has happened over the past 13 months has been a swift and most far-reaching wave of corporate restructuring. US mergers and acquisitions have fallen by more than half in terms of the number of deals and by approximately 80% in terms of deal value since the collapse of Lehman according to Bloomberg.
Whether in the consumer or industrial sector, companies that have been ahead of their peers in meeting the challenges of the recession are now prepared best to leverage their invested capital and lean balance sheets during economic stabilisation and the incipient recovery demonstrated best by improving profit margins and returns on invested capital.
Our focus in the PSigma American Growth fund is on companies wisely contracting and staying ahead of their peers doing so.
Unlike the case in early March, cheap valuation by itself will not be the catalyst for further stock gains as many companies priced for liquidation then have moved sharply higher. Outperformance going forward will reflect the actions undertaken by companies during the economic contraction.
With third quarter profit reporting underway for US companies, we expect continued positive reactions for those who are reaping the profit benefits from the powerful corporate restructuring put in place since the collapse of Lehman Brothers.
James Abate is manager of the PSigma American Growth fund
