As we enter the summer months, we are once again confronted with volatility in global equity markets. In recent times, market concerns have been macro-economically driven and this time is no different.
Strengthening corporate fundamentals, including increasing earnings and growing cash flows, are all signs that the U.S. economic recovery is well entrenched. These factors have not gone unnoticed by the U.S. equity markets, which tested new highs earlier this year. With these strengthening fundamentals in mind, the Federal Reserve Bank has signaled that it can see the time when it will begin to taper its quantitative easing program. While that time is not now – and will not be until U.S. unemployment is below 6.5% – it is foreseeable that such action may occur in the relatively near future. This will mean that interest rates, which have been at rock bottom levels the past few years, will eventually rise. This is good news, as it means that the economy is strengthening and that spare economic capacity is being utilized. Nonetheless, equity and bond markets seemed surprised by this announcement and have overreacted to it in a negative and short-term manner.
While we would not view this as a buying opportunity for bonds, we do see it as an opportunity to buy equities.
Macro factors elsewhere are less sanguine. The situation in Europe remains stressed, although some parts of Europe have recently improved from recessionary to neutral levels. It will take some time before Europe starts contributing in a meaningful way to global economic growth. Equity markets in developing areas, such as Latin America, have been beaten down of late, as growth expectations have moderated.
One of the biggest concerns in the market is the current state and future of the Chinese economy. In November 2012, there was the expected transition in China’s leadership. The new government has maintained that the country’s projected economic growth rate will remain in the range of 7.5 to 8.5% per annum for the foreseeable future. However, the new leadership is pushing through important structural economic reforms. Principle among them are new banking regulations to control China’s growing “shadow banking” activity and the further transference of business activity from state owned enterprises to privately held companies. While this reform may hamper growth somewhat during the transitionary near term, it will put the Chinese economy on a more sustainable growth path over the longer run.
In our business, we do not invest in markets or economies or governments. We invest in public companies. While we cannot ignore the macro factors that often dominate the headlines, our focus remains on owning companies that will continue to generate significant earnings and cash-flow growth in the current economic and political environment. We have increased our exposure to U.S. (and International) companies over the past two years, as we believe that the multi-national nature of these corporations offer our clients the best growth opportunities.