Henk Potts: Companies need to play catch up – invest in technology

This podcast is brought to you by ABSA, a member of Barclays. Biznews’ Alec Hogg is with Henk Potts, a member of the Barclays team in London. You’re a regular visitor to South Africa, Henk.

I am, indeed. I love coming here. It’s unusual timing for me to come this time of year so it’s interesting to see Johannesburg a little bit dustier. I normally see it when it’s green. I found South Africa such an interesting – the Gateway into Africa – and here at the conference, we’ve heard so much about opportunities. That’s a message, which I always like (to take away as much as I bring in). It’s certainly interesting and I’ll be taking that back to international clients.

On a day-to-day basis… You gave a presentation here. You went across the world in an hour. Where do you focus most of your energy?

Well, we tend to focus, of course, on the developed markets. We still see that as a very strong opportunity for investors, so we need to watch what’s happening in the United States and in Europe. Some big changes are taking place in both regions in different dynamics, of course. In the U.S., the big debate is ‘what’s going to happen in terms of interest rates? When will that first rate rise come through?’

You reckon in September.

Yes, we think September’s going to be the date for that, given the clues we’ve been getting from the FOMC. We think we’ll see two rate rises during the course of this year, with Fed Funds finishing here between 50 and 75 basis points but I think they’ll be very clear in terms of their messaging. This is a slow, gradual normalisation of policy. It should actually, be seen as positive by the global economy and by financial markets. We know the U.S. as an economy has been a patient under pressure. It has required unprecedented amounts of drugs over the course of the past few years. The patient is now starting to stand up and walk on its own, I think that will be seen as positive and companies, I think, will benefit nicely from that.

I think the economic backdrop will be strong. Corporates will continue to flourish and, other than that, it should be good news for equity markets. In Europe, of course, the debate is about the stimulus package that’s been put in place by the European Central Bank.

Let’s just stay with America, just for a bit longer. The balance sheets of Americans or multi-nationals, based in America, are massive.

They are.

I was looking yesterday at Apple with $200b on their balance sheet. What’s going to get them spending?

There’s more cash on U.S. corporate balance sheets today than has ever been the case in history, so you’re right. There is pressure on the companies to react to those conditions and they were cautious in the years after the financial crisis. It was all about health. It was able balance sheet strength. I think we’re starting to move on from that. A clear signal of that is, of course, is the merger and acquisition activity that we’re starting to see. Companies are becoming more aggressive within that arena, so it’s going to be harder for companies to grow. They’re looking to go out and buy growth. They’re looking to go out there and buy cost synergies, so that’s one area I think you’ll start seeing them deploying it.

Doesn’t that help equity markets generally, when you have that activity?

It does because the premium that they pay. I think, particularly smaller mid-cap companies will be a strong beneficiary of that, so that’s an investment area that some of our clients have been focussing on. I think they’ll be returning more, as we’ve already seen, back to shareholders, so we’ve seen big share buy-backs coming through and increasing dividends starting to come through.

Another thing I think is worth looking at, from an investment perspective, is how they use that money to invest in technology, and we think that’s going to be a big growth area, over the course of the next few years. Companies were cautious. They weren’t sure about the outlook, in the years after the recession, so they held back, but now they need to catch up some of that loss now. I think technology investment is going to be strong.

So we’ve got share buy-backs – that’s good for equities. We’ve got M&A – that’s good for equities. We’ve got an American economy that’s picking up. Would you remain in U.S. stocks?

We would do. I think the U.S. has been a tremendous performer, if you look at equity market performance. The S&P has trebled, compared to the low that we saw back in March 2009. It has underperformed during the course of this year, because it is only compared to European Markets. Slower growth anticipated in the first quarter, but we’ve also got the dynamic of the stronger U.S. Dollar, and we think that’s something that’s going to continue to appreciate and that has, at least, a short-term negative effect, potentially, on U.S. companies.

We know that demand for U.S. products starts to come under a little bit of pressure. We also know when you translate overseas earnings back into the United States it doesn’t look as pretty.

Yes, we saw that in the last quarterlies, didn’t we, with many of the U.S. companies?

Absolutely, and that’s a thing that you’ll see throughout this year. In fact, if you look at analyst’s expectations for this year, profit growth forecasts have come down substantially. Fallen by, around about 500 basis points since the start of the year, so short-term pressure, but actually analysts still remain optimistic. We started to see 2016 earnings forecast starting to pick up. I think we can be reassured by that.

Other side of that coin though, and again in your presentation, you said, “One of two things you can almost bank is that the Euro is going to weaken against the Dollar.” That must be good for European corporates.

Yes, that’s exactly right, so we know that European Central Bank, it’s a very aggressive quantitative easing program in place. A number of reasons there, we’d point to for that but, quite frankly, it should be seen for what it is, which is an aggressive move, by the European Central Bank, to devalue the Euro. If you devalue the Euro, you boost demand for European products overnight, and that’s exactly what’s been taking place. If you look at analyst’s expectations – 10 percent depreciation in Euro/Dollar, equates to something like a six to eight percent increase in corporate profitability for large European countries.

So rather invest in Europe than the U.S.?

It’s about balanced, I think. In the past few years we’ve said ‘U.S.’ – that’s where the out performances come from. As we came into this year, we actually said there’s an opportunity for investors to broaden their exposure and develop market equities to, also include Europe. Stabilisation of growth – European Central Bank, big stimulus program, the weaker Euro should make it an attractive place to invest. The earnings headroom is higher. Earnings growth will be higher in Europe, compared to the United States, during the course of this year. Valuations, as we know are, of course are cheaper. The yield dividend is higher.

The thing I found most interesting in your whole discussion was the optimism about India.

Yes, India is an economy that has massively underperformed over the course of the past few years, given the fact that it has the potential for a very vibrant, domestic economy. It has huge scale and very attractive demographics as well but what we do know is the political, the economic tide has been turning and there’s a real argument to say that India will fulfil its potential, as a pillar of global growth over the course of the next decade. The political dialogue has changed under their Prime Minister, Narendra Modi, coming to power (of course) back in May 2014, with a huge mandate for change.

The Central Bank has been gaining credibility. Inflation is starting to come under control. India is a massive beneficiary of lower energy prices as well. In the short-term, dealing with controlling food inflation, looking to reduce some of the fiscal deficits and, of course, trying to deal and address the stored infrastructure projects – encourage international investment back into India. In longer term they’re talking about urbanisation – hundreds and millions of people moving from the villages into the cities.

Henk, it’s a good story but you started-off today talking about Warren Buffett, I know it was in a joke.

Yes.

Warren Buffett loved India, until he visited and said he would never touch it. It is too corrupt.

Corruption is a problem. Regulatory issues are a problem. Infrastructure is a major problem. We know there’s hundreds and millions of people still living in poverty, so that’s not to say that there are no challenges…

How are they going to get over this corruption issue?

I think we are seeing a crackdown, a new government regime. People think corruption is entrenched within India. In the same arguments that we saw in China, we see what the government in China has done to try and turn that around. That can’t happen overnight, but I think it’s really moving in the right direction and it will become a much more attractive place for investors, on a prolonged period of time, but you’ve got to be a long-term investor. You’ve got to know the market well.

What companies can you play to enjoy the India story? Let’s given that they are going to overcome corruption, everything else looks really good, but how do you benefit?

I think you’ve got to look at sectors that will benefit from that. I think you could look at the banking sector. We expect to see significant loan growth over the course of the next few years. I think you could look at e-commerce, for example. Remember, there’s hundreds and millions of Smartphones going into that economy. Data plans will be coming far cheaper. I think the auto manufacturers will be strong as well. You’ve got very low penetration rates in India. Affordability is increasing as the country moves from a low-income to a medium-income country. Healthcare is getting stronger as well, so they’re some really strong things that you can play, when looking at India.

Henk Potts is with Barclays Research Economics and Strategy in London. This podcast was brought to you by ABSA, a member of Barclays.

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