Highly-valued growth companies came back to earth toward the end of 2018, with tech stocks hit particularly hard.Even though that bubble has partially deflated,Hudson says that there could be more pain ahead. “Valuations have come back but we haven’t seen the relationship break down yet.
“There are a number of technology companies that we look at where they are growing but they have a high level of non-recurring revenue and you have to think quite differently about what you are prepared to pay for that.”
Rising global interest rateshave been one of the most important aspects of the last year. US interest rates rose four times in 2018 and the Federal Reserve expects to lift rates twice in 2019.
“I think in an environment of rising interest rates, balance sheets come back into focus. I think that markets have become complacent about balance sheets,” says Hudson.
“We had five or six years post the global financial crisis with declining interest rates where companies were actually paid to lever up and were rewarded for that. I think that we will see the reverse in the future and people will actually appreciate companies with net cash that can self-fund their growth.
“It’s been slowly dawning on people for probably the last 12 months that the backdrop is shifting and that just probably means the easy wins are not there. You don’t get the balance sheet releveraging win just through making accretive acquisitions and you don’t get the valuation kick from being a perceived growth company – we come back to the fundamentals again.”
Interest rates on the move are also a focus for Fidelity International fund manager Paul Taylor. “Interest rates are going up in the US,” he notes. “The rising tide that lifts all ships has moderated. It’s a little tougher to get growth.
“In a low-growth environment, investors want to back strong companies with good management teams. When it’s tougher to get growth, you want someone to put forward a strong strategy and execute on it.
“We’re moving back to a period where we are focusing on cash flows and the basics of stock markets.”
He’s set to welcome change, however. “I’m quite positive for 2019,” Taylor adds. “When everyone else is fearful, we have to step into the market. It’s going to be an interesting year.”
The royal commission report due out in Februarywon’t make for pretty reading, he says, but it is expected to give investors some certainty on the banking sector.
Resources will likely put in a mixed performance, he believes, with strong balance sheets but potentially more uncertainty over commodity prices.
The property market remains fundamentally overvalued, Taylor says, although it lacks a catalyst for a really significant downturn in his view.
The election in 2019will likely be of some concern to markets, the fund manager adds, given the potential changes flagged to franking credits, capital gains tax and negative gearing.
And the risk of a recession will likely overhang markets through 2019.
“The thing that we are really watching for is recession risk that will derail the bull market,” says Schroders fund manager Simon Doyle. “We are concerned about recession risk in 12 to 18 months. Things are starting to turn but they are not ugly yet.”