What's next for equities? - an unconstrained stock-picker’s view

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Short-term tactical defensiveness may be misplaced

Hibbert, agrees we are in a bull market, that earnings growth has peaked, as have earnings revisions. Globally, we can expect an ‘mid-cycle slowdown’ in 2022. Following global shortages, inventories look likely to be rebuilt but then overshoot as supply chains look for safety, leading to an eventual slowdown.

This should not alarm investors, it’s a normal component of the cycle and we remain in a bull market, with plenty of room to run in the current cycle given the lack of material overheating in the key components of the economy, such as the corporate or household sectors.

Ignore the noise to find the real leaders

The slowdown is likely to lead to disagreements within the investment community. Hibbert is no fan of making investment decisions based on the degree to which value stocks in general are ‘cheap’ and, conversely, growth stocks are ‘overpriced’. Investing based on these types of correlations (or the lack of them) only work for a short time: they do not explain which stocks will lead the market over longer horizons.

Risk. There is no guarantee that a positive investment outcome will be achieved.

Leadership will still be in the hands of growth stocks, thinks Hibbert. He compares Google, currently on 24x earnings1, compounding revenue growth in the high teens and increasing its margins, against a typical European bank with low revenue growth, costs already taken out and a low likelihood of an interest rate cycle to improve profitability.

1Source: Bloomberg, September 2021

Risk. Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.

Different approaches suit different investor timeframes

Some investors may favour strategies that aim to deliver consistent returns over the short term.

Other investors are less concerned about quarterly or one-year performance, which is where an unconstrained strategy can come into play. It avoids the short-term noise and simply aims to look for the best opportunity set of businesses that are likely to generate strong returns for the next ten years, not just one or two quarters. These ‘duration’ stocks will always look underpriced in retrospect, says Hibbert.

Not all great franchises last, sadly. So, we constantly look for signs of disruption. Whether in San Francisco, or China, BlackRock specialists are constantly looking at private companies to spot where the next disruptors may come from, and who they may disrupt. As a result, we believe we are ideally placed to form conviction on which stocks may truly dominate their industries for the coming decade rather than ‘revert to mean’, as most people assume when valuing stocks.

Great investments outlast transitory hiccups

Now, as always, there are risks on the horizon which could interrupt the equity market. Inflation has been rising, and although some elements of this are structural (notably shelter and energy), most components are transitory and linked to COVID-induced economic shutdowns causing supply chain and labour market disruption. China’s policy shift towards common prosperity also needs to be watched closely: this type of political development explains why we leave emerging market investing to the local experts, avoiding it for our unconstrained strategy.

Turning to equity market opportunities, we think some of the most attractive companies are hidden in plain sight. Large tech stocks may appear to be popular already, but the market underappreciates their true margin potential. Take for example, a company with an EBIT (earnings before interest and taxes) margin of just 30%, despite its vice-like grip on consumer data relating to consumer preferences, when Visa’s margin is as high as 65% (Source: Bloomberg, September 2021). For us, there is material hidden value in such businesses which may truly monetise the businesses that dominate the infrastructure of the internet and new technology capabilities and a huge opportunity for profit enhancement in the coming decade.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 8 September and may change as subsequent conditions vary.

 

 

Moderator:

Joe Williams
CFA, Managing Director, Product Strategist within BlackRock’s Active Equities Group
Alister Hibbert
Head of BlackRock’s Strategic Equity Team