INVESTMENT ADVISER | ISSUE 09 2024 35
Perhaps the biggest signal from recent market movements is that the one-way certainty of the market seen in the first half of this year has reached a pause . The macroeconomic backdrop is potentially changing , or is at least uncertain , and this may change the pricing of risk assets .
If economic growth is slowing , recession risks are rising , inflation is falling , and interest rates and the cost of capital are set to decline , surely those companies that can generate revenue and profit growth against that backdrop are more valuable . This leads us back to the secular trends in the market , the wealth creation by companies exposed to the secular trends but with the competitive advantage to exploit them profitably .
In 1987 the stock market crash did not bring a major change in fundamental trends . After a brief period of accommodation by the Federal Reserve interest rates continued to rise , peaking in early 1989 at 9.75 % ( a different age ). Despite this the S & P hit all-time highs in 1989 , although the rising cost of capital did manage to puncture the bubble of the time – the Japanese equity market . My memory is not good enough to remember if there was a change in equity market leadership , but I don ’ t think there was .
What drove the market was the value creation from restructuring western companies exploiting the potential for lower costs from outsourcing and globalisation of the supply chain . This was the era of economic value added ( EVA ) and Stern Stewart , with their first big implementation being Coca Cola in 1988.4 It was the dominant trend in both management thinking and the stock market . As a result , the market was led by value stocks for two decades ( effectively 1980-2006 , with the minor aberration of the tech bubble ), as this was where the greatest value creation was occurring at the time .
Today , the average company is decently profitable . There is little to be gained from further globalisation , and there are forces in the world – both political and economic – which suggest the trend may reverse . What is driving wealth creation are those companies that can grow by innovation of new products and new ways of doing things that reduce the cost of doing business ; or by companies that can aid the process of decarbonising the world – changing the energy source of the world is a multi-decade task and will generate sales growth and wealth for advantaged companies . We have entered an artificial intelligence ( AI ) era and while the ultimate winners may be uncertain , there are some things we can say with confidence : an AI era is a cloud computing era , and the cloud is dominated by three companies . Growth looks assured and with that oligopolistic market structure wealth creation also looks certain .
Beyond the secular growth opportunities in the market , our research is focused on near-term earnings resilience and the potential in names which may see an improved outlook as interest rates are cut . In our experience , stronger competitively advantaged businesses in any industry often gain market share at a faster pace during tougher economic periods . Ensuring companies genuinely fit our quality growth philosophy is , as always , critical .
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1
Bloomberg , as at July 2024
2
Bloomberg , as at July 2024
3
Investopedia , Option Pricing Theory : Definition , History , Models , and Goals , 29 September 2021
4
JSTOR , Economic Value Added ( EVA™ ): An Empirical Examination Of A New Corporate Performance Measure , Vol 9 , No3 Fall 1997
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Issued by Threadneedle Asset Management Limited , No . 573204 and / or Columbia Threadneedle Management Limited , No . 517895 , both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority .