US 2020 Election Investment Pulse: Opportunities in Equity Sectors

Here are a few highlights from the conversation today:

• “As a growth investor focused on the US, I think we have to recognise that what’s been driving technology has been really this idea of digital transformation and how it’s affecting the global economy… We think that the election outcome only reinforces that outlook.” – Grant Bowers
• “ I think from an election standpoint, one of the things that has been good for health care is when you split the ticket in the US, and you divide the Senate and the House, you’ve removed one of the biggest sort of negative overhangs around the health care sector.”- Grant Bowers
• “I think there is an end game here, ultimately that we are more concerned about than I think the average person … which is the potential for inflation, rising interest rates, de-basement of the US currency, et cetera.” – Alan Bartlett
• “The reality is to us, if government activity at the moment succeeds, it’s inevitable that we get inflation and that ultimately ends the cycle. If government intervention doesn’t succeed, it’s inevitable that the recession is prolonged.” – Alan Bartlett

Transcript:

Stephen Dover: Grant, let’s start off with you. How has this last week’s election results and earnings results, and even COVID, how has that affected your thinking on the markets or on sectors?

Grant Bowers: I think it’s quite interesting to see how the elections are appearing to play out with very much the sort of split ticket or split ballot type of scenario with Joe Biden in the White House, a split Senate between Republicans and Democrats still really reinforcing that we’re going to be probably in a continued environment of pro-business, pro-economic growth, in the US. And I think you’re going to continue to see a lot of the big policy fears that people had of a blue wave, changing the landscape dramatically, probably are pushed to the end of the background, and we see a much more continuation of the current economic environment.

Stephen Dover: Alan, I know you think much more globally. But any thoughts, over this past week and what’s on your mind in terms of themes?

Alan Bartlett: I think, in general, what we’ve been trying to do is make sure that we have very resilient portfolios. So our strategies are very focused on broad diversification because in uncertain times, you really want to make sure that you have strong, fundamental diversification. On a valuation basis, we find more opportunities outside of the US, I mean, Japan is probably our most differentiated exposure on that basis. We think it brings a lot of the positives of some of the themes that have been driving the US in terms of technology and growth, but at a significantly cheaper price. Within the US, we’ve struggled on technology from a valuation perspective. We love growth and technology, but from a valuation perspective, it’s harder. So we tend to fish around some of the central themes that have been driving the market, looking for beneficiaries in more of the middle-ground discounts. So we do have exposure to technology stocks, but they tend to be things like technology stocks that are related to the travel industry, for example, because for obvious reasons that are priced at a significant discount.

Stephen Dover: I think that’s probably one of the biggest interests we have now is sector. So let’s talk about sectors in turn. First of all, what’s been leading the market to this week, and even this year, and that’s the technology sector. Grant, what are your thoughts around that sector? And how do you look at it going forward?

Grant Bowers: We continue to like technology. As a growth investor focused on the US, I think we have to recognise that what’s been driving technology has been really this idea of digital transformation and how it’s affecting the global economy. The move from an analog-based world to a truly digital world is still in its early days of adoption. We see it expanding beyond technology, moving into other sectors across the market. And so, as an investor, we continue to be positive on technology. We think that the election outcome only reinforces that outlook. Tech’s role as an agent of change will only grow in the next decade. We’re going to see the current COVID environment where we have a distributed workforce, we have consumers being introduced to new ways of buying things, new ways of selling, new ways of interacting are only going to drive increased adoption. And really, we’re finding many of our big technology investment themes are actually accelerating in a COVID world. And we think a lot of those are going to continue. We don’t think consumers are going to go back to many of the old traditional sort of ways that they were thinking about buying and selling goods. One other thing that I think is really important within tech that we’re keeping an eye on is this idea of an infrastructure bill. We think any infrastructure bill will include a large allocation to technology, broadband access, 5G infrastructure type of things. And, lastly, really China tensions are front and centre within technology. And I think investors should recognise that China tensions will continue, no matter who’s in the White House. We think that the current sort of outlook for US-China tensions is that it will be a continued sort of battleground, and it will be in the news, and it will create volatility for investors, but ultimately both sides need each other and we’ll find ways to work together.

Stephen Dover: So Grant, probably one of the big questions we always get asked about technology is yes, it’s growing. Yes, there’s lots of opportunity, but it’s also so outperformed this year or actually over the last few years, both in absolute terms and relative to other parts of the market. Do you still think in that sense, there’s a lot of value in technology?

Grant Bowers: I think if you describe value in a classic sense of cheap relative valuations, I would say it’s hard to make an argument that tech is cheap relative to the market. But when you look at the fundamentals of technology, that the long-term sustainable growth profiles that we see in a lot of companies, the large disruptive market opportunities that are taking place, the innovation that is actually occurring in many of these markets, that’s disrupting really old-line industries. We think the outlook for tech continues to be very bright from a valuation perspective. Technology is trading at a premium to the broader market, but only about one standard deviation higher than its historical norm. So at the upper end of the overall market. But tech is really supported by tremendous cash flows, incredible profitability of these companies. And sometimes investors like to compare it to the dotcom bubble and say, “Oh, isn’t this just like we saw last time?” Well, if you look at the actual fundamentals, technology truly hit a tipping point about a decade ago from a profitability and these businesses, whether it’s software or hardware names are generating tremendous amounts of cashflow. And we’re seeing dividend increases with many companies, we’re seeing capital return, share buybacks, a strong, robust M&A [merger and acquisition] environment. And I think overall the long-term global demand picture for tech is very strong and that’s a pretty good base for the overall sector. Valuations will come and go, and there are pockets of tech that are expensive, but there are also pockets of tech that are kind of being left behind in this market. And we think there’s opportunities out there and those areas as a growth investor, I’m sure Alan probably is able to even find some in tech within value as well.

Alan Bartlett: We will invest in any sector, any type of company, as long as the valuation makes sense. And I think the critical thing for us is to be forward-looking. So I think a lot of the arguments around the sort of growth and the value of very backward-looking, for example. So we’re not fans of a backward-looking version of value investing. We don’t think a stock is cheap just because it’s at a discount to the market on a current price-earnings or price-book basis. For example, a research focus is very much looking forward three, four, five, six years, and even longer to try and work out where the long-term winners are, but we relate that back to price ultimately. And where we struggle with technology in general is just that, that the rerating that has occurred in that space doesn’t entirely make sense to us.

And on the other side of things, we really don’t want to be taking credit risk because the amount of support that governments are given to the economy this year has acted to artificially deflate the cost of capital for a lot of companies. So we think a lot of the so-called value stocks run significant balance sheet risks going forward, whereas on the kind of higher growth side of things, it’s fundamental valuation risk. They just don’t justify that premium to other companies that are available to us.

Stephen Dover: Let’s just jump to another sector and let me ask first Grant about the health care sector. Obviously that’s the sector, at least within the United States that this election week and the outcome of this election week has an impact on. Grant, how are you looking at the health care sector?

Grant Bowers: We continue to be positive, I think on the health care sector in general. We think the long-term outlook for health care remains strong on the backdrop of a global sort of demographic wave of an aging population, a rising middle class all demanding greater access to health care, better cures and treatments and outcomes from the health care industry. And we think that longer term, the pharmaceutical industry, the biotech industry, the medical device and services industry in the US and globally will really rise to meet that demand. I think from an election standpoint, one of the things that has been good for health care is when you split the ticket in the US, and you divide the Senate and the House, you’ve removed one of the biggest sort of negative overhangs around the health care sector, which was a single-payer system or a government-sponsored health care plan that was talked about by some parts of the Democratic Party. I think once you remove that, you take away one of the biggest negatives. I think that was out there for the health care sector. So we continue to be positive on the long-term sort of secular growth outlook for health care. We also continue to be positive for health care’s role in our changing world. We think that the innovation that’s going to take place within health care is truly going to change the way we sort of live, the way we think about accessing medicine, whether it’s of telemedicine, it’s more going to be more data-centric. It’s going to be more precision-based or personalised. And so, from an investor standpoint, we see a tremendous amount of opportunity out there as health care really kind of moves from that old-line traditional business to a much more, I would say, transformative digital centric, consumer-centric business, to meet this gigantic global demand that’s out there, that is we see taking place over the next decade. So, from an investment standpoint, I think we’ve got the best outcome from the election. And I think the long-term secular growth profile of health care remains strong.

Stephen Dover: Maybe just turning to you, Alan, and talking a little bit about areas that at least have traditionally been in the value indices, and that’s the financials and the energy sector, what are your outlooks on those two sectors and where do you see opportunities or areas to avoid there?

Alan Bartlett: Yeah, they are both very interesting areas for any value investor, because both of them are optically very cheap. Certainly, if you look at the integrated oil companies, the free cash flow yields on many of those companies could buy out their entire market cap in a five or six-year view. Our strategies are actually pretty underweight energy and banks in particular, because to us price isn’t the only thing that matters to investing in a company. And we need to balance price against the longer-term growth profile. So obviously there’s a kind of environmentally ESG [environmental, social and governance] overhang to energy stocks. But, more importantly, to us is we just don’t think they are particularly defencive in a downturn in markets from here, which we’ll get a better opportunity to buy them over time. On the bank side of things, banks do look very cheap on a price basis or on a longer-term basis. But the challenge we have there is simply that we haven’t really had the credit cycle yet. And I think in banks until we see the credit cycle move on, until we see the inevitable bankruptcy cycle play out somewhat, that there are risks to being involved in developed market banks. So maybe some of them already are facing chronic situations that you’re getting in emerging markets are more interesting. But for value investors who I think many people would expect to be substantially exposed to energy and bank stocks, we’re really aren’t, and we have been in the past, but we think frankly things changed in February. And, we’re constantly challenging ourselves on that space. But we think that patience is the right mind at the moment in both of those areas.

Stephen Dover: So Alan, another area that we get asked about a lot and certainly affects value managers is the cyclical stocks. What is your thought on the cyclical sectors?

Alan Bartlett: Yeah, we are more cautious on the longer term, but we actually have pretty substantial exposure to cyclicals and industrial cyclicals in particular. I think on the basis that, regardless of whether Trump or Biden won the election, there is going to be fiscal stimulus. So there’s been a lot of questions and views over the recent days about exactly how much. But the only narrative in markets at the moment to support is fiscal stimulus and clearly that it’s going to find its way to a lot of the more cyclical stocks. So where we’ve been able to find interesting exposures at sensible prices, we’ve invested. So rather than take our cyclical risk as much on the banks and energy stocks, we have taken more of it on actually on consumer, but also on more directly industrial cyclical type businesses. I think there is an end game here, ultimately that we are more concerned about than I think the average person, which is certainly the average investor at the moment, which is the potential for inflation, rising interest rates, debasement of the US currency, et cetera. So we have a very much an eye to that. But in the meantime, we know that governments are just going to spend money until they can’t anymore. And that is going to find its way into people’s pockets. It’s going to find its way into infrastructure, broader industrial stocks. So we would rather be there than in a lot of the technology names that are at 50 times sales, for example.

Stephen Dover: Grant, maybe you can talk a little bit about the consumer sector as well as your thoughts on cyclicals.

Grant Bowers: Absolutely. I think the consumer sector is interesting. I think it’s, in many ways, at the sort of epicenter of COVID. I think you look at the travel, the hotel, the retail stocks, and really many of them have been impacted, really just tremendously in this environment. And so I guess the real question is, has it created opportunities as an investor? We have actually been finding some opportunities in the consumer sector. We think that some of the travel-related names will eventually return, that these are great businesses with long-term strong growth profiles. Consumers are going to be spending their money in a different way. They’re going to be interacting with businesses in a different way. And they’ve been introduced to a lot of new sort of ways of going about their lives. And some of those are going to stick and remain. And I think there’s an opportunity there for some of these new businesses, whether it’s e-commerce or access to health care or these types of things, or in-home exercise, and some of those will remain. But in many ways, I think the consumers will return to their old spending habits. So we’re going to see consumers return to traveling when they feel it’s safe. And we believe that COVID will pass and we will get there. We think that the housing market in the US, we’re seeing a tremendous pickup in housing, as millennials and many consumers are moving out of the cities and this idea of sort of deurbanisation, buying homes, creating households and spending money around everything that is involved in creating a household from furnishing it to buying appliances, to buying not just the home, but cars and all these types of things. And so we think there is actually a pretty good tailwind for the consumer, and as employment improves and we sort of emerge through COVID into next year that the outlook as we look ahead and really look forward is pretty bright for the consumer. But it will be bumpy along the way.

Stephen Dover: Great, thanks. Grant, talk to us very briefly about your exposure in financials, different than maybe people might expect.

Grant Bowers: Yeah, different. I think, we actually really liked the financial sector, but I would say we are very aligned with Alan, in the sense we have very little exposure or no exposure to interest-rate sensitive and bank companies. So while the financial banking sector in the US is quite strong, we just don’t see it returning to levels of growth and profitability that we saw, pre even the financial crisis. So when we look at the financial sector as a growth investor, we see a US$20 trillion market that is really anchored in its old sort of line analog-type ways. And that idea that I talked about before of digital transformation, pushing out beyond tech into all these other sectors, financials are one of the biggest opportunities out there. So we see a tremendous amount of opportunities in data providers to financials, to migrating the back offices of banks from truly paper processing to more digital electronic sort of digitisation of the consumer’s banking experience. And one of the things we talk about internally is what is the future of banking look like? And we think the future of banking is going to be more digital. It’s going to be more personal. It’s going to be truly real time. And in many ways it’s going to be more social. And so that’s going to disrupt that traditional banking model of the retail banking branch, or maybe you went to make a deposit and talk to a teller and make it much more consumer-centric. And that creates a lot of opportunity for investment for us. And so we like the financial sector, just not the traditional bank sector, which is not so different than I think what Alan has been saying about some of the financials as well.

Stephen Dover: Alan, what keeps you up at night? What’s the risk out there in the market that might happen that you’re concerned about?

Alan Bartlett: Sustainability. I think really in terms of the macroeconomic environment, I think that there’s a big difference between recovery from the awful recession, which clearly is going to happen. And then what long-term demand really is in an economy, which has grown huge amounts of debt and has lots of issues. So it’s if we just have to temper enthusiasm to things with realism about what the longer term looks like. The reality is to us, if government activity at the moment succeeds, it’s inevitable that we get inflation and that ultimately ends the cycle. If government intervention doesn’t succeed, it’s inevitable that the recession is prolonged. So we’re in a finely balanced situation. Where we’re very positive, if you like, is that as that realities sort of grinds over the next year, the volatility will be in markets that we can take advantage of. And so, as long as we’ve done the work on the stocks, we know what price makes sense. We know where we want to be. We have a focus on diversification. We can take advantage of it in order to buy bargains for our clients.

Stephen Dover: And just quickly, Grant, what is it that keeps you awake at night? Or what are the concerns that you might have for the market?

Grant Bowers: Yeah, I think our concerns are probably two-fold. First and foremost, despite the elections and everything that’s going to economy, COVID is truly the dominating force behind these markets and the economy. And until we either have a cure or a treatment or are through COVID, you can’t get a real picture for what the true economic demand is in the US or even globally, because it’s completely distorted and everything is overshadowed by COVID. If you can peel back that and look at the next level, I would say, at some levels, I do agree with Alan, inflation is probably one of the biggest risks out there in the market. We believe the Fed has essentially said that they will keep rates lower for longer. They will let the economy run hotter with more inflation and that the longer-term deflationary power and forces of not just technology, but a lot of what we talk about in our big digital transformation themes will keep a lid on inflation and that will create a pretty good backdrop and a sustainable backdrop. So I would say we are much more positive on the US and much more positive on the sustainability of growth in the US and we think that that US equities, growth equities will continue to do well in a low interest rate, relatively low inflation environment, where we have tremendous change taking place. And that’s creating a lot of opportunity for us as investors in this market.

Stephen: Thank you very much. Thanks, Grant. Thanks, Alan.

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