Risks in Asia appear more balanced, and despite the weakness in the euro area we expect global growth of around 3.25% for 2011.
A key risk to this view would be whether the US can maintain robust growth in the face of fiscal austerity and a contraction in the euro area. We believe that it can, and would draw parallels with 1993. In that year US GDP growth was 2.9% despite a narrowing in the budget deficit (of 0.8% of GDP), a decline in government consumption, unchanged policy interest rates, a contraction in euro area GDP of -0.8% and a negative export contribution to US growth.
Former glories
The US recovery was led by robust demand growth, driven by credit growth rates that were historically very low but rising. The divergent demand trends we predict for 2012 are therefore not unprecedented, and we would expect some outperformance given that US growth has underperformed the euro area over the past six years.
During 2011 picking the right stock was often inconsequential, and the market ended 2011 with very high levels of correlation. We expect 2012 to be different. There are enough wrinkles in the macro to give way to more differentiation between companies.
A preference for global over domestic stocks is our point of departure rather than our destination. There are a number of different elements to our strategy:
- Weak euro area demand is likely to be most evident in the contraction in capex in Europe. The sovereign crisis has caused an increase in borrowing costs across Southern Europe and the companies affected might be some of the first to cut back on their investment plans. If this happens their suppliers could end up struggling;
- Some companies will be more vulnerable to the inventory cycle turning and margin contraction if demand contracts;
- Our preference overall is for the right kind of globally exposed stocks where the EV/FCF has fallen to levels that look attractive. Keeping an eye on cashflow is obviously advisable in this environment. Cyclicals such as: Royal Dutch Shell, SKF, Daimler, UBM, Antofagasta and AMEC, and across the defensives Tate & Lyle, Reckitt & Benckiser, Remy Cointreau and Telenor;
- The tightening in credit conditions might also have knock on effects on other regions such as Eastern Europe and Latin America. Our preference is for the US and to a lesser extent Chinese over Eastern Europe and Latin America;
- We are reluctant to jump to any lazy conclusions on how European globally exposed cyclicals have got to be cheaper than their US counterparts (with a similar global reach) because in many cases they just aren’t unfortunately. For those that are a flag definitely needs to be raised, but we have looked in detail at this and find that only a few look good value such as Royal Dutch, Volvo, Air Liquide and SAP;
- Between the local markets in Europe, the UK is our favoured way of playing global growth with only 15% sales into Europe. The FTSE is a more global equity market than the DAX.
If you’re feeling as exhausted as we are with the macro we have searched for companies that we deem ‘macro insensitive’. This is not to be confused with defensives. These are companies that have not re-rated or de-rated during the cyclical/defensive rotation this year. We look for growth stocks within this overlooked segment.
With concerns over the sustainability of dividends, a strategy focused on which companies are set to increase dividends or do a buy-back or special dividend is likely to produce better results in our view than a straight dividend yield strategy. Company balance sheets are in good condition and we need to position ourselves to best capitalise from that. Monitoring dividend actions also gives us a good indicator of which companies are feeling more confident about things and a bit of visibility is likely to be handsomely rewarded in this market.
A dividend increase often precedes an earnings upgrade. In the UK we are seeing more dividend increases than in Europe, but we look across Europe for companies where the payout ratio looks too low.
Our top 10 strategy picks for 2012 are: SAP, Royal Dutch Shell, SKF, Linde, William Demant, Telenor, Reckitt Benckiser, AMEC, Swatch and UBM .
