Today, the rest of the world is valued at a 40% discount to US equities – and this discount is as extreme as it’s been in 25 years. But a new CAPEX cycle evens out the playing field.
Given the US is home to big cap tech, secular trends around software and the internet have disproportionately benefited US equities. Whereas emerging investment cycles around decarbonisation and investment will benefit companies globally, not just in the US. This extraordinary premium for US equities is unlikely to be as sustainable as many believe.
Business resilience will be rewarded
Investors should position for an ongoing rotation in market preferences and in an environment where inflation proves sticky, owning resilient businesses with embedded growth is key to this. Market leaders are in a better position to manage inflation through their cost base and pricing power.
The consolidation in cyclical stocks in recent months provides an opportunity to position for this rotation at attractive valuations.
Dutch banking giant ING Group is a great example and a beneficiary of ongoing European reopening. It is a well-capitalised retail bank with more than half of its loan book in Northern Europe and around half in residential mortgages, where it is a dominant player. ING isn’t under threat from savvy fintech and is arguably the original disrupter given its predominantly online business model.
As regulators lift restrictions on distributions, ING has scope to lift its payout ratio given considerable excess capital. This can act as an additional catalyst for re-rating. We see the company valued at 10x earnings with a sustainable 8.5% dividend yield.
We also own Oracle Corporation, an incumbent software platform that looks cheap relative to its growth rate and cheap relative to smaller peers. Oracle’s revenue will accelerate as database workloads transition to the cloud, and as the company takes share in cloud ERP where it is the leader.
We are comfortable taking exposure to sensibly priced large cap internet and software businesses that are well-positioned for long-term structural trends like cloud, social commerce and digital advertising. We struggle to rationalise the valuations of their smaller, narrower competitors.
Conclusion
In this environment of very easy money, markets are not pricing credit risk and we’re not seeing the normal cleansing of weaker competitors.
Disruption is real. Not all low multiple stocks are interesting, there will be some that are permanently disrupted – we need to avoid the value traps.
But not all high-flyers are genuine disruptors, and growth traps will be revealed.
As a pragmatic value manager, it’s about having exposure to companies across the growth spectrum, that are attractively priced for their growth profile – simply speaking, avoiding value and growth traps.
