Navigating risk and seizing opportunities

Understanding and navigating risks and identifying and exploiting opportunities are the core capabilities of any competent investor or company executive. Yet, we currently see both groups struggling, being hypnotised by over-blown potential risks and paralysed in the face of potential growth opportunities.

Caught in a (QE) trap

After a volatile week in most equity classes where we are now and, more importantly, where are we heading? Most casual observers of the markets last week will have been left with the impression that equities took a beating based on lowered growth assumptions for emerging markets, fears over deflation/stagnation in the Eurozone and heightened geopolitical concerns. However, after sharp falls in the middle of the week equities rebounded on Friday and ended almost flat on the week (S&P 500 up 0.6%, FTSE 100 down 0.9%).

So what was the momentous news on Thursday evening that turned it all around? Was it better than expected industrial production figures out of the US for September or reassuring earnings releases for 3Q (out of the 81 S&P 500 companies that have reported third-quarter results, 64.2% have beaten expectations, a rate slightly below the average over the past four quarters but better than the past 20 years). No, it was calming comments by policy makers that rate hikes will be delayed beyond the current expectations and asset-buying by the Fed may/may not end soon.

All this goes to show is that what is driving investor sentiment at the moment is not a rigorous analysis and appreciation of fundaments (macro, corporate or geopolitical) it is simply an addiction to stimulus by central banks.

That markets will become more volatile after QE programs end should not surprise anyone (QE1 and QE2 were followed by sharp declines in equities) and the beginning of a rate hiking period has always caused a rebalancing of portfolios (with some asset classes declining in value while others see strong gains).

Policy makers need to be stronger in their resolve if we are to break this cycle of reliance on artificial measures to drive economic and corporate performance. We need to return to a more normalised situation where growth is achieved by growing revenues, increasing productivity and reducing costs.

Can corporates save the day?

One other artificial stimulant that investors have become increasingly reliant on is share buybacks. With increasing amounts being spent by corporates to enhance EPS it is no wonder that equities are at such elevated levels. But this is not a long-term strategy for growth. With record levels of cash and relatively low leverage corporates can and should be investing in their own growth strategies, either through capex or through M&A. We have seen this year that a well thought out deal, with a strong value creation strategy underpinning it, will be positively received by the market.

If we are entering a sustained period of lower-than-average growth (I’m looking at you Eurozone) those companies that make the move to utilise the current benign funding environment and elevated equity values in order to increase market share and gain efficiencies through consolidation will be best placed to create real value through the near-term.

UK OK?

The latest assessment of the UK economy by our very own ITEM Club paints a mixed picture. While growth is better than most developed economies the analysis does show a tempering of growth in 2015, caused by a variety of factors including the impending election, the slowing Eurozone, and wider global concerns. What is encouraging for UK PLC is the elevated investment we have seen by UK companies. We just need to see them continuing this trend so as to take advantage in the coming years.

The first wave of investment is now well under way, but on the ground businesses are becoming nervous. They are faced with an uncertain domestic political situation, while there are renewed concerns about their key export markets. They haven’t pulled on the reins just yet, but there is a definite sense of caution. This is a time for cool heads.

Over the top or just good business

A good example of a company exploiting an opportunity is the news that Time Warner will start offering its premium channel HBO to customers via a stand-alone net based subscription instead of the usual cable or satellite bundle. This is also a window on how advances in the digital sphere are disrupting current business models.

What is interesting about this move is that it impacts not only the cable and satellite companies that have been the main beneficiaries of delivering premium content up until now it also dents the model of other internet-based content aggregators, who had been the initial movers in breaking the traditional TV-based entertainment landscape that has been with us for the last 50 odd years.

No sector is immune from the changes being wrought as we move deeper into this tech/media/telecom revolution and it is those that plan best for what will be happening in five or even ten years’ time that will benefit most.


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