Industry Voice: Neil Robson, Head of Global Equities at Columbia Threadneedle Investments, says investors are preoccupied with the prospect of a global downturn. Instead, they should be looking at how technology and other factors are transforming business models - this is the key to identifying the stars of 2019.
After a bearish end to 2018, financial market participants are preoccupied with the question of whether a global downturn is imminent. Yet they should be asking a different question: have they accounted for the way that technology and other factors are transforming business models?
After all, the average company's earnings have moved sideways for a decade. Technology firms are among the few ‘superstars' that have famously grown earnings in this time, although in fact there are less well-known companies in almost every sector that have done so.
While we do not expect an imminent recession, these are uncertain times, especially with the looming threat of a trade war. Consequently, we are looking to invest in tomorrow's superstars - companies with a robust competitive advantage. Typically, they have significant barriers to entry, the ability to gain market share and many harness transformational technology.
McKinsey & Company, the management consultancy, coined the term ‘superstars' for these businesses. It recently published research showing that the top 10% of companies capture 80% of all economic profit among companies with annual revenues greater than US$1 billion.1 Investing in these companies, many of which are changing the nature of industries and society, can be rewarding over the long term.
Overstated risk of recession
Turning to the market's obsession with recession, we would argue that the global economy is only half way through its current cycle - certainly, financial markets are not showing the signs of stress to be expected at the end of a cycle. Growth may be slow, but there are no real reasons why it should stop.
Are common assumptions about the nature of economic cycles correct? By most reckonings, the global economic recovery is in its ninth year, which would make this one of the longest cycles on record. But economic growth was flat in 2010, 2011 and 2012. So, did the recovery really start in 2013?
Additionally, the nature of the cycle is changing. In the 19th Century, economies were predominantly agricultural and weather dependent. Recessions happened every other year - one year was good and the next tended to be bad. The 20th Century's (mainly industrial) economy typically had an inventorydriven recession one year in four. Today's service economy sees individual sectors experience recessions frequently without precipitating a widespread downturn. For instance, the industrial sector entered a recession in 2015-16. The Chinese automobile industry is in recession right now. In the 21st Century, global recessions do not happen as often as before simply because the global economy is so diversified.
The most significant exogenous threat is the possibility of a trade war. The United States feels threatened by a resurgent China that has doubled its share of GDP from 4% to 8% since it acceded to the World Trade Organisation in 2001. It justifiably resents China's restrictive practices. But does Donald Trump want a high-tariff or a low-tariff world? He appears likely to want a zero-tariff world, but he also wants fair access to China's markets.
Looking for game changers
Looking to 2019, one should not be fooled into thinking that cheap companies represent an attractive buying opportunity. Innovators are disrupting markets, undercutting prices and driving down profit margins. A well-known example is the retail sector, where consumers are turning away from the high street and to the convenience of online shopping. Amazon and Alibaba's sales now account for more than 1% of global GDP. Bricks and mortar retailers are cheap for a reason: society is changing.
Outside the tech sector, Mastercard is a good example of a superstar company. Mastercard and Visa control around 85% of the global card market, excluding China. Because the industry structure is so advantageous, Mastercard makes north of 40% on invested capital and its revenues are growing in the high teens, as the number of purchases made using plastic increases by over 10% a year. Meanwhile, Mastercard is large enough to be relatively unaffected by local shocks such as Brexit. That said, Mastercard must guard against challengers.
Brexit is one obvious challenge for companies. Our biggest exposure is Cooper Industries, a US business which makes contact lenses. It has a disproportionate amount of its manufacturing in the UK and would, therefore, benefit from a collapse in sterling. The immediate aftermath of the Brexit vote in June 2016 showed what might happen in the event of a hard Brexit. As it stands today, if we had a hard Brexit tomorrow and sterling collapsed, we would benefit.
In 2019 we will remain dedicated to pinpointing companies that successfully operate in difficultto-access areas. They are overwhelmingly harnessing societal change and technology, instead of swimming against the tide.
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