Don’t be fooled by the bounce back

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By Duggan Matthews

In the face of tremendous geopolitical uncertainty, markets in 2016 were characterised by a rebound in previously out-of-favour currencies, sectors and stocks, while the winners of the previous decade lagged.   This ‘bounce back’ can largely be attributed to an uptick in commodity prices which provided a boost for resource stocks and developing markets, but are these returns sustainable?

Over the long-term returns are ultimately sustained by earnings and dividend growth. In Marriott’s view, consumer- facing multinational companies will continue to offer the best dividend growth prospects in the years ahead.  Weak demand and an oversupply of resources will likely keep dividend growth from commodity-linked investments subdued; while a rapidly growing consuming class and technology-enabled efficiencies will see robust dividend growth from the companies with the world’s most sought after consumer brands.  Powerful brands also guard against disruption, arguably the most significant investment risk of the next decade.

2017 and beyond

There are 4 key trends to consider when choosing an investment for the long-term:

  1. Consumerism

The GDP growth of many major emerging markets is increasingly being driven by household spending as they transition from investment-led to consumption-driven economies. Over the next 5 years it is anticipated that incremental consumption growth in China and India alone will roughly equate to a market the size of Japan.

Consumer facing multinationals with meaningful footprints in the developing world will therefore benefit from what we believe to be the most significant growth opportunity of the next decade.

  1. Disruption

Nothing warrants more careful consideration from a risk perspective than disruption. Technology – unlike Trump and Brexit – can completely redefine markets. Take for example, the impact of e-commerce on traditional retailing. Over the last 15 years the revenues of Kmart (America’s 3rd biggest retailer in 2000) have declined by two-thirds while Amazon’s annual sales increased 30 fold. The chart below highlights the extraordinary size of Amazon and compares its growth to the growth of 8 well known brick and mortar retailers since 2006.

To guard against the risk of disruption the multinationals we invest in:

  • Manufacture and distribute basic consumer products like food, soft drinks and personal & homecare products where the threat of advancing technology is considered to be low.
  • Have powerful brands, reducing the risk of being removed from the supply chain (disintermediation).

Companies that avoid disruption are likely to be major beneficiaries of technological innovation in the years ahead.

  1. Efficiencies

Advancing technology is undoubtedly a key risk, but it also presents investors with a major opportunity. The World Economic Forum points out that up until recently, those who have gained the most from technology have been consumers.

In the future, business is expected to be the next major beneficiary of technology, through long-term gains in efficiency and productivity – a trend already being referred to as the 4th Industrial revolution. General Electric (GE) for instance, is connecting its factories to the internet and analyzing the collected data to optimise how they run. The company is factoring in a $1billion cost reduction by 2020 and intends doing something similar for its customers.

Cisco – a worldwide leader in IT – estimates that automation will produce a bottom line improvement for global businesses of approximately $14 trillion over the next decade; this represents approximately one fifth of current global profits.

By ensuring we invest in companies that are less likely to be disrupted, investors stand to benefit from the technology-enabled efficiency and productivity gains discussed above. Widening margins will likely result in more dividend and capital growth from our chosen multinationals which already stand to benefit from the rapidly growing consuming class in the developing world.

  1. Rising bond yields

The outlook for equities may be positive; however this is not the case for bonds. Since Trump’s election in November last year the US 10-year bond yield has increased by approximately 0.5%. Rising bond yields results in capital losses for investors and, the expectation is that yields could rise further.

Donald Trump has promised to lower taxes and spend billions of Dollars on infrastructure. This is widely expected to result in higher GDP growth, but will also likely lead to higher deficits, inflation and interest rates – all bad news for bond investors.

It should be noted that while Trump may be considered bad for bonds, this is not the case for equities. Lower taxes and higher government spending in the US will further boost the dividend growth prospects of all the multinationals we invest in.

Summary

Markets in 2016 were characterised by a rebound in previously out-of-favour currencies, sectors and stocks, while the winners of the previous decade lagged.  Over the long term, however, returns are ultimately sustained by earnings and dividend growth.

In our view, consumers facing multinational companies continue to offer the best dividend growth prospects in the years ahead due to the following:

  1. A rapidly growing consumer class in the developing world,
  2. Improving margins as a result of technology-enabled efficiency and productivity gains; and
  3. Higher government spending and tax cuts in the US.

As such Marriott’s advice for investors is not to be fooled by the bounce back in commodity-linked investments and that multinationals with powerful consumer brands remain the best place to be invested for the long term.