The market at large and the Growth Fund in particular suffered an extremely difficult last quarter in 2018, as the post financial crisis bull-market rolled over. Investors increasingly worried about the impact of tightening monetary policy and trade wars on global economic growth. The domestic outlook remained clouded, as it became clear that the government’s exit deal with the EU did not command enough support in the Parliament, bringing the possibility of a general election and an investor unfriendly hard left Labour government to the fore.
From the Fund’s perspective, the initial risk-off trade in October heralded a somewhat indiscriminate sell-off in AIM stocks, which were perceived as higher risk because they trade on the junior market, with the Fund suffering from its relatively high AIM weighting, designed to give exposure to the technology and other high growth sectors. We used the sell-off to build up weightings in some of our preferred tech stocks like dotDigital and Quixant at what we felt were attractive valuations. Another theme throughout the last quarter was a somewhat relentless decline in the price of overseas industrials on worries about a slowdown in industrial production on the back of trade wars, signs of which are beginning to emerge in China. Oversold UK domestic cyclicals where the Fund only has modest exposure remained subdued, but with relatively full employment and modest rises in real earnings, in some instances they held up challenges or disappointing on profits were sold-off sharply. Perhaps the most severely impacted theme was the highly rated momentum shares, which have been a one-way upward ride for the last few years. The Fund avoided the worst of this sell-down having been quite active through the year in selling down it’s more expensive stocks, where we were struggling to justify forward valuations.
Going into 2019 we are faced with a sea of political uncertainty. On the home front it looks likely that the government will fail to deliver it’s BREXIT deal and could lose control of the process to a Parliamentary free-for-all. Given that a majority of MPs won’t countenance a no-deal solution, the likelihood seems to be either for a softer version of what’s currently on offer which would be seen as good for the economy, or a delay of the whole process prolonging the existing uncertainty. To this extent we’re still happy to have a relatively low UK cyclical exposure. Globally, having pump primed the US economy with tax cuts post his election, its seems unlikely that the President will want to de-rail the economy ahead of the next election with ongoing trade wars. It would make sense for him to “trumpet” another great deal for America by securing some concessions from the Chinese, on the back of which the industrial slowdown we have started to see could be quite shallow, with a resumption of growth in the latter part of 2019. However, whilst nothing can be certain with Trump, in our view our industrial holdings, on an EV/sales analysis, are already discounting quite a meaningful slowdown in industrial activity. Notwithstanding a more bearish industrial backdrop, it’s worth reflecting that global inflation is still relatively low and monetary policy (whilst no longer at the extreme end of lax) is still relatively benign, neither of which suggest a sharp slowdown in global GDP is likely let alone inevitable. On this basis, equities, particularly UK listed ones, which have sold off particularly severely, whatever their end markets, in our view look extremely attractive.
Overall both throughout and before the drawdown we have been quite active in selling down the Fund’s most expensive stocks, where we have been struggling to justify their valuations and investing in cheaper screened alternatives. These actions coupled with the effect of the sell-off have left the Fund trading at by far its lowest forward aggregate PER valuation since launch with a PEG on our estimation and based on consensus forecasts of close to one. Barring an outright recession, which we don’t anticipate, we feel our screened investment universe of cash generative companies with high margins thanks to economic moats, and high levels of revenue visibility is throwing up some compelling investment opportunities, which should continue to serve us well through 2019 and beyond.
