Brexit clouds the international growth lens

Prior to the Brexit decision on June 23, global economic, financial and geopolitical conditions were fragile and arguably fraught with no shortage of uncertainty. The outcome of Britain’s referendum vote was therefore anything but welcome, catching many by surprise. Since then:

• We’ve seen further cuts to global growth expectations
• The dollar has rallied, reclaiming some of the ground lost through the spring as incremental Federal Reserve (Fed) hike expectations were pushed out
• Bond prices have been bid up, recently taking yields to lows not seen in more than a century, according to market historians, given the increase in uncertainty and expectations of further monetary easing
• Global share prices have risen over the past few weeks after a dramatic but short-lived decline

The dislocation in the bond and equity markets over the past few weeks is difficult to reconcile. However, both appear to be anticipating delayed incremental Fed intervention, further deposit rate cuts and the extension of quantitative easing in Europe, as growth, inflation and interest-rate outlooks have taken yet another step lower after the Brexit vote.

“EQV” in the broad market

Looking at the current broad market landscape through our Earnings, Quality and Valuation (EQV) lens, we observe the following:

• It’s concerning that the main driver of equity performance since the U.K. referendum appears to be falling bond yields, which reflect lower growth and inflation expectations – key inputs into earnings and cash flows
• Corporate balance sheets and returns on capital have deteriorated in the past 12 months, as management teams have increased leverage to buy back shares or fund dividend payouts, a manufactured form of return that began to look played out earlier this year
• Led by an extended U.S. equity market, global valuations offer little room for error should growth disappoint further. Global valuation multiples are full-to-expensive, whether prospective or adjusted, or based on cash, earnings or assets

In short, the EQV data points we are seeing across the market are less than inspiring at this juncture, making the task of deploying capital with one eye on positive return potential and the other on capital preservation all the more challenging None of this changes our bottom-up stock-picking discipline. We believe our high-conviction approach, focused on fundamental company research, can benefit investors over the long term.