As markets predict a shift amid interest rate expectations and a barrage of elections throughout 2024, John Bailer (pictured), deputy head of equity income at Newton IM, believes it’s time for investors to look towards “cheaper” options.
That is, cheaper than the ‘Magnificent Seven’, who has an average price-to-earnings ratio over 40, to American giants like JP Morgan Chase, who Bailer believes are more likely to prove beneficial in a changing market environment.
“We’ve lived in a regime after the global financial crisis of very cheap money, low interest rates, and low inflation, so that led market participants to gravitate to stocks that could grow irrespective of economic growth. A lot of the magnificent seven stocks fit that bill.”
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Bailer believes a turning point for the market was Federal Reserve chair Jerome Powell’s speech near the end of 2021, where he said inflation was no longer transitory as rates began to move higher. While many growth stocks performed well in 2022, Bailer called this a “last gasp” for their outperformance.
“That tends to happen in the market. You tend to go back to what has worked over the last decade, but I do think there’s a regime change. We’re going to stay higher for longer and inflationary pressures are going to be a normal 2 to 3% level. We’re not going back to deflation again. And that’s going to lead us more value-oriented stocks in the market,” Bailer said.
The market changes have led Bailer to some of the “cheaper” stocks on the US market as he sees a widening ratio between the price-to earnings on the cheapest and most expensive quintiles of the US market.
“It looks very much like the tech bubble in 1999. And when that happens, when you have such a wide variation of the most expensive stocks in the US market versus the cheapest stock, it pays not to focus as much on earnings growth in terms of looking at stocks that are going to outperform over time,” Bailer said.
“It actually is a good time to start focusing on what you’re paying for the stocks. Because what happens when all the enthusiasm goes away for whatever that theme is at the time, PE multiples tend to compress. So even though those companies can grow faster than those cheap companies in the market, they tend to underperform because they get rerated lower.”
Bailer also pointed out that in the US market, the cheapest area of the market does not equate to a bad business. He has a top-ten in JP Morgan Chase, which has a 11.26 price-to-earnings ratio in comparison with Nvidia’s 73.93. And while the stock has not jutted up at the same rate as Nvidia’s 233.2% in the last year, it has still increased by 41.7%. Bailer also cited a dividend yield for JP Morgan of 2.3%, which has increased by 15% in the last year.
“The perception is, if you’re focused on that cheapest area of the US market, you’re buying bad businesses,” Bailer said.
“And that’s not the case. You can buy one of the best businesses around run by one of the best CEOs around, Jamie Dimon, at a very good price in that lowest quintile evaluation.”
Dividends
Like in the case of JP Morgan, Bailer finds dividend payouts to be a compelling argument for companies. While dividends can sometimes spark unease in a company if they have to be scaled back, Bailer finds appeal in the discipline it puts on a company.
“If they’re paying a dividend that’s growing, I think that’s a great indicator that they have cash flows that are robust and can grow over time,” Bailer said.
“What’s important in the US market is our payout ratios tend to be lower. So we have dividend yields that are lower than the rest of the world in a lot of cases. But we have better dividend growth prospects, because of our payout ratios. That’s what makes the US market a little bit unique, you can get some dividend yield in the US market, but you can get very good dividend growth and that can protect against inflation.”
Bailer also pointed out the advantages of dividends for aging investors, who may want to see investments begin to payout, especially amidst a more uncertain future for the market.
“We spent 10 years here in an everything goes up market. I don’t think that’s going to be the case going forward. I think we’re going to have more muted returns. So, you’re going to want to start off with a nice income stream. Before you invest in the company, I think you’re going to want that that income coming from it.”
Elections
As the US elections in November creep closer without a clear outcome, many have been left unsure how tides will change in the market with the candidate’s differing policies. However, Bailer has approached the situation by looking at where Joe Biden and Donald Trump seem to be more aligned.
“Clearly we have two individuals that are different, but they do have some similarities, which are going to help certain areas of the US market. One of them is they’re both populists,” Bailer said.
“They both believe in spending money. And they both believe in reshoring and bringing jobs back to the US.”
In 2022, Biden passed the Inflation Reduction Act, which including an estimated $500bn in spending and tax breaks to invest across sectors including energy, manufacturing and the environment in pursuit of clean energy. The 2021 infrastructure bill, worth $1trn, energised spending in the US for construction including roads, bridges, pipes, and powerlines.
The economy stimulants have pushed the success of companies like CRH, a supplier of building materials for construction products, and one of Bailer’s top ten holdings.
“This is a company that should benefit from all that spending from those fiscal policies. And I think both President Biden and President Trump would be totally supportive of those spending priorities,” Bailer said.
“This is a company that looks like it has great prospects going forward for the next three, four years, as we spend more and more money redomiciling a lot of the manufacturing and also spending a lot of money on the roads and bridges that have already been allocated through some fiscal spending that has been passed.”
