Bulldog – The Pedigree to Succeed in a Slow Growth Economy
Volatility has ruled for the past two months serving as a painful reminder to investors the risk to the reward of an elongated U.S. bull market. The timing of Fed Lift off, a slumping Chinese economy, routed commodities and the dreaded R word creeping into select economic forecasts for the U.S. economy among other factors are fueling uncertainty in global markets. Unlikely that these disconcertion’s will be resolved before 2015 rounds out we need a north star to orient our expectations for this year and beyond. As always, we turn to earnings to anchor our market sensibilities and shape our outlook.
Despite the uncertainty that pervades, we are assured in our forecast that 2015 S&P earnings will be recorded as largely flat or just a hair ahead of last year. Our expectation of $118, give or take a couple of dollars puts the S&P 500 on a 2015 multiple of 17x as I write today. More tellingly, revenues for the S&P are going to decline this year versus last. We see evidence of wage pressure together with interest rates and credit spreads creeping higher. These two major cost inputs point to a tougher margin environment for companies going forward. Such as recipe cooks up a problem for earnings unless broad global economic activity picks up, not something widely forecast for 2016. Under these circumstances you are counting on multiple expansion for stock prices to move higher, yes that can happen particularly if interest rate increases get pushed out into next year, but you are blowing in the winds of ‘data dependency’ if that is your base case.
Putting all this together results in muted expectations for the broad market. But, that’s okay because the broad market is not a panacea for investment success, focusing on great companies doing great things regardless of prevailing market or economic conditions is. Take Apple as a great example, between 2008-2015─an economic period often characterized as the worst for half a century─ the company grew its earnings over 1000% and the stock price ascended in harmony. Other examples include Visa (500%), Starbucks (400%), Google (300%)…the list goes on. During the same period the U.S. economy has expanded on average just over 2.0%. The point should be made that these are revenue driven increases in earnings not engineering through buybacks or M&A etc.
So why have these companies been so successful while the broad economy has been pedestrian? The answer: Their Bulldog qualities. When the economic pie is not getting bigger, in order to survive and thrive you need to take market share from your competitors or, in the case of the companies above, greater share of your wallet. America hasn’t had a real pay rise for a decade but during that period we have managed to carve out $200 per month for smart phones, $10 per week on coffee and have reallocated 60 minutes of our daily attention to the internet, Facebook and You Tube (Google) almost exclusively. The money and time to accomplish this is being taken from other sources. Earnings forecasts for Walmart, McDonalds, JC Penney, The GAP, Coca-Cola, IBM all show a flattening and in some cases a declining trend in top and bottom line growth. These iconic companies may offer value but without growth and/or PE expansion their stock prices are dead in the water.
Our Chairman Jim Moltz taught us that “buying stock in a company that takes market share is the only insurance policy one can get.” Bulldogs are all about growth in units, real growth. Few other breeds of strategy are likely to succeed as this slow growth economy persists.
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