Q&A: Why growth now?
There are a multitude of reasons why the global economy is experiencing muted growth: from domestic, economic and fiscal woes and conflict in the Middle East to the seemingly never-to-end eurodebt overhang. But for growth investors like Aash Shah, Federated Kaufmann senior portfolio manager, the cloud of uncertainty that has kept investors from venturing into the market may only be adding to the case for large-cap growth.
Q: What’s driving opportunity in large-cap growth today? A big reason is strong valuations. Since 2008 as the fear trade took hold, most investors have moved away from growth funds and poured into Treasuries and other havens. As a result you now have large growth companies that are generating significant cash flows and trading at better prices than a similar portfolio of value stocks. It’s something I haven’t seen in more than 20 years of investing.
If you wind the clock back to late 1999 into early 2000, you saw exactly the opposite phenomenon. Growth companies, especially many of what we now consider the bellwether tech and telecom companies, were very hot and very expensive. These same companies currently are trading in single digit or low double digit price-to-earnings ratios. So we believe the combination of excellent growth stock valuations and improving global economic conditions are creating a substantial, potentially once-in-a-generation opportunity.
Q: Are you optimistic about economic growth in the U.S.? I’m certainly not pessimistic. One reason is that housing—the catalyst that led us into the downturn—is starting to pick up. We don’t believe it’s going to be the booming sector that will lead the way to full recovery—no more than the tech sector could have led us out of the tech bubble back in the early 2000s. But we’re finally seeing evidence that housing has stopped being a drag and can actually start to become additive to GDP growth.
Another factor is a strong comeback for the auto industry. Auto sales are at five-year highs, over 15 million vehicles—this is up from 11 million three years ago. The auto industry is one that generates enormous profits once it accounts for the significant fixed costs needed to pay salaries and maintain factories. So if sales can move up by another one to two million units, the industry can start to play a big role in the recovery. As auto sales increase, there’s a multiplier effect for auto parts and components, dealers and retailers up and down the supply and delivery chain.
Beyond those industry considerations, we’re still in a situation where we can expect two to three more years of accommodative interest rates and a U.S. banking system that has been recapitalized and in position to extend credit at attractive rates. Admittedly, the banks haven’t been making a lot of loans yet because the demand still isn’t there. But between the housing and auto industry recoveries and the accommodative monetary policy, we believe GDP growth can move from 1.5% to 2.5%. That, in turn, can bring down the unemployment rate and unleash more pent up consumer spending.
Q: There’s also China’s sluggish growth—and, of course, Europe. Are you concerned? At this point, there’s very little reason to expect a hard economic landing in China. They just had their once-in-a-decade leadership change. Those leaders are going to be very attentive to avoiding political and economic risk. They control 100% of the banking system and have a closed economy where the leadership controls where the money is spent. That’s not to say they can’t misspend the money—the previous regime oversaw the development of an enormous real estate bubble. But lessons were learned and they do want to keep their people employed. So they will be investing heavily in infrastructure, basic housing, schools, and hospitals. And they are going to continue building their retail investments because they are intent on growing a strong, self-sustaining consumer culture within China.
As for Europe, the debt crisis is severe, but it is not a calamity. The economy is not destroyed; there is still demand for products and services. This is a debt restructuring problem and they are slowly—and for countries like Spain, Italy and Greece—painfully working through that debt. The European Central Bank has lowered interest rates; they are extending maturities. Bottom line, we see zero to minimal growth for Europe in the short-term, but not a steep downward slide.
Q: What other opportunities are you seeing? Throughout China—and India, among other developing nations—you’re looking at enormous populations moving from the countryside into the cities. Most farming in these countries is still done by hand. So food inflation has gone through the roof and the need to put in place vastly more efficient, large-scale agricultural systems is urgent. This is a clear opportunity for manufacturers of farming and construction equipment.
In general, there’s going to be more industrialization and more construction throughout the developing world. So we are evaluating companies that do the mining, metals and materials-related work.
Telecom is another growth sector. Just consider that the volume of cell phone usage in China is about eight years behind that of the U.S. And it’s not at all unusual for Americans to change out their phones every year or two. When you apply that kind of consumption to vast populations—just in Asia alone—there is tremendous potential for those well-established, innovative companies that make phones, data chips and related components.
The rapid growth of the middle class across emerging economies means that what we have already experienced in this country in terms of demand for products, services, infrastructure and basic needs is repeating itself among enormous global populations. The challenge is to identify which companies are in position to meet those needs and deliver the best opportunity for investors.
Thank you, Aash.
