It has been a good decade for equity markets. Many investors in global equities have made large gains and would like to protect them. Yet while we manage our fund with this preference in mind, that does not mean we believe the bull market in equities is about to end.
Simon Edelsten, Artemis Global Select Fund
MSCI AC World: Cumulative return vs return by year
Source: Refinitiv Datastream as at 29 November 2019.
While 2019 saw a slowdown in global growth, we believe 2020 will bring a slight reacceleration. With little sign of inflation in Europe and Japan, bond yields should remain very low. So – however reluctantly – investors may continue to look to equities for income.
By this time next year, the US will have (re-)elected a president. After four years of Mr Trump, Wall Street might welcome a moderate Democratic candidate, should one emerge. The new European Parliament will have launched a fresh range of policies, probably including some element of fiscal stimulus. We would also hope for some progress on Brexit.
We prefer developed markets
While politics should become less of a concern in developed markets, political instability may well hang over some emerging markets. We are not alone in seeing developed markets as being more secure areas in which to invest. This has led to a large volume of savings funnelled into a relatively short list of well-known stocks, driving some to rather high valuation multiples (share price expressed as a multiple of underlying free cash flows). It is the most richly valued stocks that fall hardest in any correction.
Our approach – Hasten slowly…
Ours is a cautious approach to investing. This has led us to reduce the funds’ exposure to the most fashionable stocks in recent years as their valuations have – in our view – become stretched. Overall, while the share prices of our holdings have generally risen, that has been matched by a rise in their underlying cashflows. So – in contrast to the wider market – their valuation multiples have not increased.
Avoiding stocks threatened by technological change
At the same time as being cautious on the most fashionable stocks, we are avoiding stocks in sectors that lack barriers to entry or are threatened by technological change like old-fashioned retailers, oil and gas companies or carmakers. We believe they present more risk than opportunity.
Where we find growth
We have investments in companies that design semiconductors for artificial intelligence and 5G telecoms. We have investments in cloud computing companies, which should benefit from further growth in data traffic. The other half of the portfolio is invested in areas that grow more slowly but have good defensive qualities. These include affordable healthcare companies, windfarm developers, drug companies developing successful modern cancer immunotherapies and even forestry businesses.
Outlook for US equities
Cormac Weldon, manager of the Artemis US Select Fund
William Warren, manager of the Artemis US Extended Alpha Fund
As we enter 2020, the prospects for the US economy and stockmarket remain as uncertain as ever. In part, this is because we think that this year’s strong performance from the stockmarket – despite political and economic worries and tensions over trade – distorts the real picture somewhat. The run-up to the presidential election adds a further layer of uncertainty. So what can we expect in 2020?
The economic cycle has been extended
For some time we have been saying that economic growth has peaked but the cycle has been extended. We still expect growth of 1-2% next year. But we will be keeping a close eye on business confidence which has weakened this year. This has resulted in less capital investment, but not lower employment at this point.
US consumer confidence remains strong
Source: Bloomberg as at 30 November 2019
If we saw a further weakening in business confidence, we would become more concerned. Issues we would look out for include an escalation of the trade war and the prospect of a left-leaning Democrat being elected.
Assuming there is no further intensification of the trade wars, we do not envisage the US entering a recession next year. While we still await details of a final deal with China, the key aspect is that there is no further increase in tariffs and the possibility of rolling back some of those already in place.
Can the consumer come to the rescue?
It’s worth remembering that the US economy is 70% dependent on the consumer. And here the picture is still positive. Employment prospects remain very good, wages are growing and people generally have low levels of debt. As a result, consumer confidence and demand are high and this is helping to offset lower capital expenditure.
Politics and populism
Looking ahead to next year it is clear that politics will play an important role in markets. While investors have got used to the Republican brand of populism embodied by Donald Trump, they are increasingly considering the possibility of a more left-wing version embodied by Democrat candidates Bernie Sanders or Elizabeth Warren. At this point, the more moderate Joe Biden is still leading the Democratic race. If he wins the nomination, polls currently suggest that he would defeat Donald Trump in November 2020. If that were to happen, the market would need to digest the end of Trump’s deregulation and market-friendly policies and consider whether it outweighs the ending of his trade wars.
The presidential election and the market
On balance, we think a Trump victory would be positive for stockmarkets and a Biden victory neutral. But the race for the nomination is far from over. If Warren were to be nominated, we think her current policies make her unelectable. So that news would have a negligible impact on markets. However, it’s still early days and many things can change before the nomination is confirmed next summer. We will know more in early March, after the so-called ‘super Tuesday’ of Democratic primaries.
Interest rates likely to be on hold
The Federal Reserve cut interest rates three times in 2019. We expect little change next year. This will support markets.
We expect companies’ profits to start growing again
For the first time since 2016, corporate profits shrank in the third quarter of 2019. While some of this was due to the trade tensions, a comparison effect is also at work: last year’s profits were boosted by tax cuts, making them harder to beat. We expect profits to start growing again from this point.
US consumer confidence remains strong
Source: Bloomberg as at 30 November 2019
Outlook for European equities: From a standpoint of ‘style’
Paul Casson, manager of the Artemis Pan-European Absolute Return Fund
A battle is raging within European equity markets. For popular stocks, there currently seems to be no upper limit to how much investors are prepared to pay. For unpopular stocks there seems to be no lower boundary. We call this a style bubble.
The relative performance of Growth, Value and Quality in Europe
Source: Kepler Cheuvreux. Data as at 26 November 2019
Value stocks are being unfairly overlooked
Contrast this with 2019’s losers: value stocks. Some are now trading back at levels that prevailed during the global financial crisis. Analysts have been raising their earnings forecasts for these companies – but this is roundly ignored by the stockmarket. Many offer well-supported dividend yields which should be attractive in a world starved of income – but their share prices imply that it isn’t. Others are in cyclical industries where being in downswing has been interpreted as a long-term ‘structural’ failure. Only time will tell if this is correct. In all cases there are bargains to be had, if investors are willing to take them.
Outlook for European equities: taking the long-term view
Mark Page and Laurent Millet, managers of the Artemis European Opportunities Fund
The situation at the end of 2019 is the mirror image of last year. In 2018, stockmarkets fell ahead of an expected economic slowdown. Markets had anticipated the negative impact that the US-China trade war and rising political uncertainty would have on the economy and on companies’ profits. By contrast, the negative sentiment at the start of this year was a good inverse indicator of how the share prices would perform – European stockmarkets have risen roughly 20% year-to-date.
Trade wars and politics affect profits
The stockmarket has gone up despite global economic growth slowing. The slowdown has been mainly due to the lagged effect of earlier interest rate rises in the US and the escalation of the trade war between China and the US. As a result, companies’ profits have stagnated. Despite this, share prices have risen.
Yet equities are attractive relative to bonds
At the end of October (according to Deutsche Bank), 23% of all bonds in the world and 5% of global corporate investment-grade bonds were trading on negative yields. By comparison, equities looked attractively valued – 94% of European stocks were yielding more than the Barclays European Corporate Bond index.
Are forecasts for profits too high?
Equities’ future performance will probably depend on whether companies can grow their profits. The consensus forecast is for around 10% growth in profits in Europe next year. Unless there is a meaningful rebound of economic growth in 2020, this is probably too optimistic.
Consumer goods stocks at risk
One area that we think is particularly at risk is consumer goods. Unemployment is low by historical standards and the main economic risk is that lower profits in manufacturing companies lead to job losses and lower consumer confidence. Domestic demand has been resilient so far but there are signs that this is changing. Consumer goods stocks have performed very well. We think they are vulnerable to a potential spill over of economic weakness from the manufacturing sector.
There are still attractive opportunities
For long-term investors, the challenge is to neither compromise on quality nor on valuation. We define ‘high-quality’ companies with low debts, high returns on equity and predictable earnings. There are a number of such companies in the pharmaceutical and industrial sectors that look well placed to grow their earnings and cashflows sustainably – even in a tougher economic environment – and yet are attractively valued. If the downside risks materialize, the ensuing correction in the market would almost certainly create a buying opportunity in some great companies temporarily mispriced by a short-sighted market.
Outlook for emerging markets
Raheel Altaf, manager of the Artemis Global Emerging Markets Fund
During 2019, the fundamental attractions of emerging-market equities were largely overshadowed by macroeconomic factors and political worries. A period of weaker growth in the global economy, the lack of resolution in the trade negotiations between the US and China and bouts of geopolitical uncertainty all weighed on sentiment towards what are still perceived as riskier investments. The result was that although emerging markets produced positive headline returns, developed markets – particularly the US – fared much better.
A dismal decade
Emerging markets have now been significant laggards for a decade. While the S&P 500 index has more than tripled over the last 10 years, emerging markets have underperformed significantly.
A dismal decade – relatively speaking – for emerging markets
Source: Refinitiv Datastream as at 31 October 2019
Challenges exist – but they may already be ‘in the price’
Undoubtedly, some developing economies will suffer should tensions over trade continue – or escalate – in 2020. It appears that the decades-long trend towards the ever closer integration of the global economy, from which emerging markets have directly benefited, is being called into question as populism becomes a political force. The long process of globalization may now be going into reverse.
At the same time, investor positioning may already reflect this threat. Heightened risk aversion for much of the last decade has meant less capital has been allocated to perceived risky assets such as emerging markets. ‘Safe havens’ have been preferred – returns from government bonds and US equities since the global financial crisis reflect this. Yet for stockpickers prepared to look beyond the headlines of trade wars or Trump’s latest tweet, today’s bad news might be providing tomorrow’s opportunity. The moves that Asian economies in particular have made to protect themselves from demand shocks from the West has made them more self-sufficient than in the past.
Valuations and investor positioning both suggest many geopolitical risks are already in the price. So if growth turns out to be better than expected – or if tensions subside – emerging-market equities could suddenly represent an intriguing contrarian trade. We can see five reasons to hope that relative returns from emerging markets could improve in the short term.
- Support from China: There have been recent signs of improving economic data, particularly from China’s manufacturing sector. There is also the potential for further policy easing from Beijing in the coming months, which would lend additional support to domestic demand and activity in the service sector.
- Easier monetary policy: Emerging markets stand to benefit from looser central bank policies. An easing in financial conditions globally should flow from the Fed’s recent interest-rate cut. With inflation generally benign, a synchronised easing of monetary policy across emerging markets would be likely to stimulate growth.
- The possibility of a deal on trade: While an escalation of the trade war between the US and China undoubtedly represents a risk in the short-term, we expect to see these tensions easing ahead of US elections in 2020.
- Valuation support: Valuations also make the case for emerging markets, where stocks are trading at levels slightly below their historic average. This is not the case in some other equity markets. Emerging markets continue to offer a significant discount to developed markets.
The valuation gap between US stocks and emerging markets has widened dramatically
- Increasingly shareholder-friendly policies: Investors tend to regard state-owned enterprises (SOEs) as being mere instruments of local governments that pay too little regard to their minority shareholders. But there are signs of positive change here. Governments are realising that by improving corporate governance, they can unlock value in their assets. For example, the Russian government recently pushed state-controlled Gazprom to increase the dividend it pays to its shareholders. The Chinese government, meanwhile, is pushing the country’s SOEs to lead by example by reforming their corporate governance. We believe this could unlock value and, in time, start to reduce the valuation discount on which these companies typically trade.
The longer-term case…
So we can see good reasons to hope that returns from emerging markets relative to their developed peers could start to recover in the year to come. At the same time, investors with slightly longer time horizons currently have a window of opportunity to buy into the long-term potential of emerging markets, which we believe remains undimmed.
The arguments for long-term allocation to emerging markets have been well rehearsed. At its most basic, emerging market companies offer investors the opportunity to buy exposure to economies where GDP growth is faster than in developed markets. The expanding middle classes and increasing dominance of domestically focused brands should, for instance, underpin long-term returns from the best emerging market consumer stocks.
Three areas where we find opportunities today…
Russian stocks offer a dividend yield that is more than double that of other emerging markets. And a number of Russian companies – Gazprom being the highest profile among them – are moving towards adopting more shareholder-friendly practices.
There is scope for the earnings multiple (share price expressed as a multiple of underlying free cash flows) on Chinese equities to move higher as capital markets are progressively opened to international investors. Mainland listed ‘A-shares’ stand to benefit as a wider pool of investors access to a market characterised by strong earnings growth and attractive valuations.
The pursuit of safe havens or mechanically buying into the market’s previous winners – momentum investing – has created an unusually large valuation gap between value and growth stocks. Value stocks are trading at unusually depressed levels. At times in the last 18 months this discount has threatened to shrink, but value stocks have not had a persistent period of outperformance – yet…
Bear in mind too that conditions faced by value stocks in emerging markets are quite different to those confronting their counterparts in developed markets. Favourable demographics, increasing urbanization and the need to invest in infrastructure mean the growth prospects for, say, a Chinese cement manufacturer look far brighter than for its European or Japanese equivalent. Similarly, the growth prospects for a Chinese bank are much more appealing than for a retail bank in the mature markets of Europe.
Fixed income – from a corporate viewpoint
Stephen Snowden, manager of the Artemis Corporate Bond Fund
From an economic perspective, it is useful to distinguish between longer-term ‘structural’ forces and shorter, ‘cyclical’ dynamics. On occasion, these will pull in opposing directions. Structurally, the global economy faces some formidable challenges. Economic growth has been slowing for decades. Halting this trend will be challenging; reversing it will be practically impossible.
Economic growth globally remains in long-term decline
Source: World Bank as at 31 December 2018.
The private sector lacks the confidence to invest for the long term
One structural challenge – the aging population – can be offset by improving productivity. This requires investment in technology, education and infrastructure. These are long-term decisions. Yet despite low funding costs, the private sector seemingly doesn’t have the confidence to commit to transformative levels of borrowing.
Western governments appear unable to look beyond the next election
In the absence of long-term investment by many companies, we are left in the hands of politicians. Unfortunately, their horizons seem to end at the next election. To win, they increasingly rely on populist measures: increasing spending rather than investing for the long term. Investment bears fruit over a longer period than the electoral cycle – the payback comes too late for the politically ambitious.
Structural challenges make ‘normalization’ of monetary policy unlikely
Structurally, we have moved into a new regime. In the absence of long-term investment, interest rates are unlikely to normalize for many years. Asset purchases by central banks – quantitative easing – may continue. Economically and socially this might be a depressing prospect, but this represents a benign, supportive environment for bond markets.
A cyclical upswing seems possible
From a shorter term, more cyclical perspective, the global economy currently faces a very favourable policy mix. In 2019, central banks stopped raising rates and turned back to quantitative easing. The novelty is not what central banks are doing, but the fact that a more liberal approach to government spending will complement monetary policy. The change in direction is modest so far but broad-based enough to support economic activity.
Risks for 2020
While we are optimistic on the short term, cyclical outlook, there are risks. Employment trends are no longer improving. To date, strong employment, higher earnings and low inflation have all supported consumer demand. But if this dynamic changes, then the outlook would become more uncertain.
A favourable outlook for corporate bonds
We expect the government bond market to be well-behaved in 2020. Low government bond yields have also helped the corporate bond market by squeezing the premium that companies must pay to borrow. The global hunt for yield should, we think, favour corporate bonds. Modest economic growth, meanwhile, is typically healthy for corporate bonds – not so recessionary that it causes damage, nor buoyant enough that it might lead to overenthusiastic borrowing by companies.
To ensure you understand whether these funds are suitable for you, please read the Key Investor Information Document which is available, along with the funds’ Prospectus, from www.artemisfunds.com.
Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund’s value.
Artemis Global Select Fund, Artemis European Opportunities Fund, Artemis Strategic Bond Fund, are authorised unit trust schemes. For further information, visit www.artemisfunds.com/unittrusts.
Artemis US Select Fund, Artemis Smaller Companies Fund, Artemis US Absolute Return Fund, Artemis US Extended Alpha Fund, Artemis Pan-European Absolute Return Fund, Artemis Global Emerging Markets Fund and Artemis Corporate Bond Fund, are sub-funds of Artemis Investment Funds ICVC. For further information, visit www.artemisfunds.com/oeic.
Artemis Global Select Fund:
Emerging markets risk: Compared to more established economies, investments in emerging markets may be subject to greater volatility due to differences in generally accepted accounting principles, less governed standards or from economic or political instability. Under certain market conditions assets may be difficult to sell.
Artemis US Select Fund:
Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
Artemis US Smaller Companies Fund:
Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
Smaller companies risk: Investing in small and medium-sized companies can involve more risk than investing in larger, more established companies. Shares in smaller companies may not be as easy to sell, which can cause difficulty in valuing those shares.
Artemis US Absolute Return Fund:
Absolute return risk: The fund is not guaranteed to produce a positive return and as an absolute return fund, performance may not move in line with general market trends or fully benefit from a positive market environment.
Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
Cash risk: The fund may hold a large amount of cash. If it does so when markets are rising, the fund’s returns could be less that if the cash was fully invested in other types of assets.
Artemis US Extended Alpha Fund:
Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
Cash risk: The fund may hold a large amount of cash. If it does so when markets are rising, the fund’s returns could be less that if the cash was fully invested in other types of assets
Artemis European Opportunities Fund:
Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
Smaller companies risk: Investing in small and medium-sized companies can involve more risk than investing in larger, more established companies. Shares in smaller companies may not be as easy to sell, which can cause difficulty in valuing those shares.
Credit risk: Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
Artemis Pan-European Absolute Return Fund:
Absolute return risk: The fund is not guaranteed to produce a positive return and as an absolute return fund, performance may not move in line with general market trends or fully benefit from a positive market environment.
Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
Cash risk: The fund may hold a large amount of cash. If it does so when markets are rising, the fund’s returns could be less that if the cash was fully invested in other types of assets
Artemis Global Emerging Markets Fund:
Emerging markets risk: Compared to more established economies, investments in emerging markets may be subject to greater volatility due to differences in generally accepted accounting principles, less governed standards or from economic or political instability. Under certain market conditions assets may be difficult to sell.
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Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
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China risk: The fund can invest in China A-shares (shares traded on Chinese stock exchanges in Renminbi). There is a risk that the fund may suffer difficulties or delays in enforcing its rights in these shares, including title and assurance of ownership.
Charges from capital risk: Where charges are taken wholly or partly out of a fund’s capital, distributable income may be increased at the expense of capital, which may constrain or erode capital growth.
Artemis Corporate Bond Fund:
Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
Credit risk: Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
Bond liquidity risk: The fund holds bonds which could prove difficult to sell. As a result, the fund may have to lower the selling price, sell other investments or forego more appealing investment opportunities.
Artemis Strategic Bond Fund:
Special situations risk: The fund invests in companies that are in recovery, need re-financing or are suffering from lack of market attention (special situations). These companies are subject to higher-than-average risk of capital loss.
Credit risk: Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
Higher-yielding bonds risk: The fund may invest in higher-yielding bonds, which may increase the risk to capital. Investing in these types of assets (which are also known as sub-investment grade bonds) can produce a higher yield but also brings an increased risk of default, which would affect the capital value of the fund.
IMPORTANT INFORMATION:
Third parties (including FTSE and Morningstar) whose data may be included in this document do not accept any liability for errors or omissions. For information, visit www.artemisfunds.com/third-party-data.
Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness.
Any forward-looking statements are based on Artemis’ current expectations and projections and are subject to change without notice.
Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.