Archived News 16/10/2018
Productivity growth to the rescue
The Cornelian Investment Team views productivity as the key to investment returns and explains why in the article below.
US earnings grew by an extraordinary 25% year on year during the second quarter, far exceeding expectations. Corporate profits have grown sharply thanks to a resurgent economy and President Trump’s tax reforms. This has led to the sharp outperformance of the S&P500 index.
Emerging market equities have struggled as the rising US Dollar has put the spotlight on those economies with structural weaknesses.
Elsewhere across the globe, returns have been less appealing. Emerging market equities have struggled as the rising US Dollar has put the spotlight on those economies with structural weaknesses. More idiosyncratic has been the impact of political risks on the United Kingdom’s stock market where international investors have fled the field.
The good news is that it is probable that we are close to the point of maximum uncertainty concerning the Brexit outcome. We believe the risk of a ‘cliff edge’ hard Brexit is low. Even if there is a ‘no deal’ outcome, we expect the European Union to agree to extend the UK’s unfettered access to European markets to the end of 2020 in line with the UK’s budget commitments. This will give time for the government and companies to plan a more orderly exit. If correct, it means that international investors may soon start to sniff out the value to be had in the UK.
The long-term trend of global trade integration may be about to be checked by President Trump’s desire to rebalance global trade. He is right to call for Chinese protectionist barriers to be brought down. These were erected (correctly) when China joined the WTO in December 2001 as an emerging market.
The good news is that it is probable that we are close to the point of maximum uncertainty concerning the Brexit outcome.
We believe a deal between the United States and the Chinese will be forthcoming after the US mid-term elections. China has already started to reduce tariffs and open up their markets. Furthermore, the number of sectors where foreigners are barred from investing has been reduced and the compensation cap for intellectual property infringement has been raised.
Technology stocks have driven markets higher, but what is being missed by investors is that the technology on offer (internet of things, big data, automation, artificial intelligence, etc), combined with high speeds of data transmission and raw processing power means that digitisation is set to drive enormous productivity gains for companies that successfully incorporate these technologies into the delivery of their so called ‘old economy’ products and services.
This dynamic will very likely ensure companies’ labour bills will not race away even if wage growth is beginning to accelerate.
For us, this is the key to positive future stock market returns as improving productivity will ensure core inflation will remain relatively well behaved despite the increasingly tight labour market and, therefore, central banks will not need to increase interest rates by significantly more than currently expected, which would impact asset valuations negatively.
Sources: Bloomberg, Bank of America Merrill Lynch, Cornelian Asset Managers, Financial Times, S&P
Cornelian Investment Team