The Artemis US Select Fund invests in a relatively concentrated portfolio of the ‘best ideas' generated by Artemis' US equity team. Fund manager Cormac Weldon takes a flexible, pragmatic approach, which means that position sizes reflect a stock's upside potential (and downside risks) rather than its weighting in the index. In this article, Cormac provides his views on the market and explains where he is finding opportunities.
Since the fund launched in late 2014, we have stated our view that we are in the late stages of the current economic cycle. The US economy has grown steadily for a number of years. Companies have benefited from this and profit margins are relatively high. Employment has increased and there are signs of wage inflation. That said, over the past year we have also stated our belief that there is no imminent threat of recession. That view has been influenced by the fact that consumers are being supported by rising wages and low inflation.
As we look forward, however, it does appear that the risk of a slowdown in the US economy at some point in the next couple of years has increased. Corporate credit has become more expensive and not only for energy companies borrowing in the high-yield bond market. Banks are tightening credit standards, which will have a dampening effect on economic growth, probably starting later this year.
Our real concerns, however, surround the prospects for growth outside the US. Globally, debts have not fallen since the financial crisis. In fact, governments and companies in emerging markets are significantly more indebted than they were at the time of the crisis. Our best guess is that China will be able to pursue an ‘extend and pretend' policy towards the debts accumulated by its corporate sector. At the same time, we acknowledge this is likely to dampen economic growth. Furthermore, there are big risks, including a devaluation of the renminbi, if the process cannot be managed smoothly.
But despite our caution on the economy we can still find attractive stocks. The stockmarket is a ruthless discounting mechanism so many of these worries are already ‘in the price'. A number of stocks have underperformed significantly over the past couple of years. In some cases, this has been due to slowing economic growth outside the US (a strong US dollar has also hurt exporters). In other cases, exposure to steep falls in energy prices has been to blame.
A good example of the type of company we have been buying in recent months is CF Industries. Its core business - turning natural gas into fertiliser for sale in the US market - is relatively simple. The price of fertiliser is heavily influenced by global energy prices, which might have squeezed its margins. But a combination of milder-than-expected weather and increased production ensured the price of its main input - US natural gas - fell precipitously. In the past year, CF bought assets outside the US, not a move we supported at the time. So we sold our holding. The share price has since halved. And with earlier deals now closing, the company should able to use its prodigious free cashflows to buy back shares.
From our point of view, CF ticks a lot of boxes. Having underperformed very significantly, it is cheap. Its domestic focus means it is less exposed to the slowing growth in the global economy, giving it a significant competitive advantage over international rivals. In addition, we believe that oil prices over the next few years are likely to be higher than they have been in the recent past - which should support fertiliser prices.
As the US election approaches, we are wary of the healthcare sector. The healthcare system in the US is grossly inefficient and wasteful compared to other developed countries and the medical outcomes tend to be inferior. Moreover, it tends to become a political football in election years. So we believe the sector will remain under pressure, with weak sentiment holding down the valuation multiples investors are prepared to pay. The fund remains underweight here.
It is in technology where we do see opportunities, associated with the ever more data-intensive economy. The demand for storage goes on growing but there seem to be limits on its supply. Most providers of enterprise and cloud services have done all they can with compression and will have to start buying more storage to meet demand. Capacity in the newer technology, NAND flash memory, is not growing fast enough so hard disk drives will remain the low-cost option for years to come. This is dominated by the two remaining manufacturers: Seagate and Western Digital, both of which we hold in the fund.
