No end in sight for the semiconductor revolution
January 30, 2019
American Funds video transcript: “Opportunities and risks in global equities today”
Will McKenna: I love that concept of the multilocal companies. I wouldn't be surprised to see an article about that on Capital Ideas soon. Can you say a little bit more about that? Maybe there's an example of a company who's doing some of those things to establish themselves in this kind of multilocal, more nimble way?
Jody Jonsson: Well, right now, if you look at consumer staples companies, for example, many of them are really struggling to grow their top lines. And whereas emerging markets used to be a very strong source of growth for them, it's slowed down considerably. In part, the emerging markets consumer is just better satisfied in terms of their needs for consumer staples. But increasingly, in China, India, Latin America, there are very, very strong local competitors. It sort of fits with the theme of millennials wanting products that are more authentic. And so, I think you're seeing the same thing in terms of emerging markets consumers looking for brands where they feel like they know that local consumer. They trust that brand. And so, these smaller, more nimble competitors are coming up to scale very, very quickly and really challenging the big global multinationals.
So, some of the advantages that used to hew to those larger companies are less of an advantage now. So, I find those companies that are able to break themselves down and be more nimble and think faster — launch products more quickly, be more experimental — are probably better positioned in the long run.
Will McKenna: That’s great. Great to hear where you and the team are seeing opportunities out there in the markets. But what about the risks? I mean, here we are late in the cycle. There must be things that you're keeping your eye on. Where do you see the risks in the equity markets as you travel them?
Jody Jonsson: Well, in the U.S. in particular, we are starting from high valuations. We're certainly in the top decile of S&P 500 P/E [ratios] relative to the market’s own history. And so you're starting from a fairly elevated position. From that level, risks are going to be magnified.
In particular, as Darrell has mentioned, earnings are pretty strong in the U.S. right now. But as interest rates rise, the P/E on the market is gradually compressing. So, we could have a period where the market goes sideways or even goes down, not because there's a problem with earnings or the economy, but just because the market is normalizing again in terms of valuation. I, personally, am not looking for enormous gains from the U.S. equity market this year, even if we do have very strong earnings for the market overall.
I also think we're starting to see some signs of end-of-cycle behavior, whether that is an increase in M&A activity, not so much for cash, but for stock; [or] certainly on the financial side of things in terms of debt, both private equity, in particular, a lot of covenant-lite loans and much higher levels of debt to EBITDA in private transactions. We're starting to see some IPOs that are little bit flaky, both here and in places like China, and again, I think, all your typical signs of excess, like housing prices in coastal cities around the world. It's all been a function of cheap, easy money and a period where QE reigned. And now, when we go from QE to QT, a lot of those excesses will start to unwind, and they could show up in places that we don't expect.
Darrell mentioned already that we see a lot more goodwill on company balance sheets and more leverage, and I would agree that paying attention to balance sheets and cash flows is something we need to be much more vigilant about now. We've gone from a part of the market cycle where it's all about earnings to, now, you have to hunker down a little bit more and make sure you have protection on the balance sheet.
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