The August bank holiday weekend means different things to different people. For revellers and festival goers, it is one last hurrah before the summer season draws to a close. For analysts it represents the end of another long results season. I’m very much in the latter camp these days. Time to take stock.
If one looked purely at the ghastly headlines that have been plastered across the papers, one could have been forgiven for thinking that we’d have seen a deluge of profit warnings. Inevitably, we’ve seen a few, but the half year reporting season has been relatively plain sailing. How can this be? The papers tell us we have rampant inflation, energy and food prices are escalating uncontrollably and supply chains are in total chaos.
The answer is twofold. Firstly, it’s never as bad as the press make out. Their job is to sell newspapers and generate clicks on screens. It has been irrevocably proven that the best way to do that is to shout as loudly as possible about bad news. It’s always X amount of billion being ‘wiped off’ the value of the index that gets the most column inches.
Secondly, macro indicators usually pertain to what I (with my analyst hat firmly on) would refer to as a consumer’s income statement. In other words, their immediate incomings and outgoings. Employment and wage growth are revenue changes, inflation and tax are expenses. The current dynamics may not be as terrible as the papers say, but they are no doubt unpleasant. Wage growth is rising, but even if it keeps pace with inflation, the tax burden means we’re all getting poorer. And that’s before we think about mortgage rate increases soaking up more disposable income. Around 100,000 households a month are remortgaging onto more expensive deals as fixed deals mature.
However, this all ignores what I would call the consumer’s balance sheet. This doesn’t get the attention it deserves. In the pandemic, incomes were supported by government schemes but expenses (foreign holidays, new clothes, pub trips, commuting costs etc) were significantly reduced. This created a succession of month-end surpluses, which were squirrelled away or used to pay off credit card debt. I saw a piece of research by Deutsche Bank which estimated UK excess saving balances are still around 10% of GDP. That’s less than the peak levels, but still very high. Of course, this won’t last forever. But it does perhaps point to a softer landing than one might have expected.
These factors help explain why total year to date returns remain positive in most major markets, despite interest rate hikes and macro concerns.
So where do we go next? The bulls will point to valuation being significantly less demanding than has been the case in recent years. And they are right to do so. Markets do not look expensive. However, there are still reasons to be fearful. We do not think all companies will navigate through the coming months unscathed.
The impact of tightening has not yet been fully felt, especially by those in the 25-35 bracket. After striving to buy a house for years, the next thing that happens is monthly repayments skyrocket. In contrast, the government’s triple lock means the state pension is increasing faster than working people’s wages. Relatively few retirees even have a mortgage balance, and those that do will often have lower balances. Perhaps this explains the profit upgrades at cruise liners and fashion groups that target the more senior consumers.
Our investment strategy is not as simple as trying to capitalise on any grey boom. The reality is that as the cushion of excess savings reduces and the full effect of the interest rate hikes kick in, we could see life become more difficult for some businesses. In such uncertain times, we think client money should be invested in those companies that have the best chance of preserving profitability. The best way to do that is to identify those which hold the most valuable asset of all – pricing power. Companies that sell value-add products and services not only generate high margins in the first place, but they can easily push prices on to customers who have little choice to pay up.
Of course this is not a golden ticket to security, but if high quality businesses with dependable revenue streams start feeling the pinch, we can bet it’s a lot worse elsewhere. I remain happy that markets will trend up if we are patient enough, but with the potential for speedbumps ahead, I am more convinced than ever that quality remains the place to be for now.
With a slightly uncertain investment backdrop, perhaps it’s appropriate that this week’s teaser comes via some Blur lyrics. Why did Grandma get new dentures?
George Salmon – Senior Investment Analyst
All charts and data sourced from FactSet
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