Good Value Briefing | Goldilocks: perhaps a fairy-tale, but markets still present opportunities

Key points  

  1. The pathway for inflation is down, but a key point of contention is if sticky rents prevent the Fed from achieving its target. 
  2. Expectations around rate cuts in the US have tempered but there’s still risk the pace of loosening disappoints – this can impact asset prices. 
  3. While uncertainty persists we’re still relatively defensively positioned but selective cyclical opportunities have emerged from a potential recovery in global industrial production.
  4. We discuss two global cyclicals we’ve been buying which sit at interesting supply and demand inflection points, and can be supported by  structural tailwinds 

 As the S&P 500 continues to set new records, the market is taking the view that inflation has been tamed and rates can fall while economic growth and employment remain intact. Whilst expectations around the pace of loosening have tempered over the last month, the market believes that even if the world’s largest economy doesn’t quite stick the perfect landing, the Fed has the wiggle room to prevent a hard landing.  

 This is one possible outcome.  

 However, we also see alternate potential outcomes ahead with risks around an inflation wall and lagged ramifications of tight policy.  

 We agree that the pathway for inflation is down, but we see core inflation getting stuck around 3% mid-year due to a sticky shelter component – which is basically rents – and potentially geopolitics. It’s worth paying attention to shelter as it accounts for 40% of core inflation. Rents are still rising faster than 6% driven by a large and continued undersupply in US housing. This will keep feeding into core CPI – and higher rents were a key factor keeping US core inflation unchanged at 3.9% yoy in January, which took the market by surprise. Consistent with the caution expressed by Jerome Powell recently, the “last mile” may be harder to achieve than the market expects, and 3% may be too high for the Fed. 

 In just the last month consensus has shifted from 140bp in rate cuts over 2024 to closer to 80bp.  

 We’ve likely seen the peak of the tightening cycle but the Fed still finds itself in a difficult position. If it cuts too early, it could reignite inflation given the persistent strength of the US economy. The risk remains that the pace of loosening disappoints. In our view investors need to be open to rates remaining higher for longer.  

 While the US economy has been resilient so far, the risk also remains that it also isn’t bullet proof. The transmission of tighter monetary policy to the real economy has lengthened. We know that 30-year fixed rate mortgages have protected US households from higher policy rates, consequently supporting consumption. However, the threats of monetary tightening may not have passed. The labour market continues to loosen, albeit unwinding from very tight levels, nominal wage growth is slowing, the household’s excess savings from COVID stimulus has all but been run down. If this persists it could have implications for consumption.  

 Taking the barbell approach  

The Antipodes global portfolios retain their relatively defensive tilt. Merck and Sanofi (pharma with a pipeline), Oracle and Microsoft (cloud migration and AI beneficiaries) and American Electric Power (beneficiary of the energy transition investment cycle) remain core holdings. They’re great examples of companies where earnings and cash flows aren’t dependent upon economic outcomes, and they are mispriced relative to their business resilience and their growth profile.  

But we can’t ignore that the global industrial production cycle has been weak. 

This weakness has been driven by the slowdown in manufacturing, as consumers pivoted away from consuming goods to services post COVID, and China’s property crisis and lacklustre economic rebound hasn’t helped. This has washed out global cyclicals.  

That doesn’t mean all global cyclicals are interesting, however there are some with attractive long-term supply and demand dynamics that are showing bottom of the cycle characteristics such as inventory destocking, low levels of inventory, weak pricing and are priced on low multiples as investors assume the current weakness in the cycle will be more permanent. We’re using this as an opportunity to selectively add.    

Daimler Trucks, the world’s largest truck company, is a good example. Daimler principally operates in oligopoly markets in North America and Europe with relatively high barriers to entry given the investment required to deliver at scale a broad service network essential for the business-critical nature of the product they support – delivery trucks that sit idle are cost centres. Daimler has made significant physical and digital investment in the service network to deliver rapid turnarounds, in as little as 24 hours.  

Daimler Truck has a 40% share of North American heavy trucks and 20% of the European market. The demand for trucks is inextricably linked to the macroeconomic cycle – simply, the stronger the economy, the greater the demand for goods and the more trucks you need to move these goods. Near term volumes have been hampered by weaker demand for goods (at the expense of services) and headwinds from China, however looking beyond the near term, regulation that mandates lower emissions from trucks will prompt an almost inevitable recovery.  

Today’s valuation of 9x forward earnings compensates for near-term cyclical risks and provides adequate margin of safety given the strength of Daimler’s truck franchises, and the company has a strong balance sheet which it is using to buy back stock. 

French listed building materials company Saint Gobain is another example. The building industry accounts for 40% of global carbon emissions, and heating and cooling is a big part of this. Saint Gobain’s focus is energy efficient materials and light and sustainable construction – 75% of its turnover is related to sustainability including glass wool insulation, lightweight and recycled materials. It’s the first company globally that offered zero carbon scope 1 and 2 glass and plasterboard. It will be a beneficiary of regulation and stimulus packages to lift building energy efficiency standards in Europe, which will require renovation rates to increase three-fold to meet policy makers’ targets. The company will also benefit from the upswing in housing as aging stock in developed markets is replaced and renovated, the underbuild is rectified and urbanisation continues in emerging markets. This is a cyclical business with some interesting structural tailwinds which we can buy at 11x forward earnings. 

If it does become more apparent in the data that the Fed can cut rates and the economic backdrop remain resilient, we will lean into our cyclical exposures – both our mature cyclicals and those beneficiaries of long-term investment trends around energy transition and supply chain onshoring such as long-term portfolio holding Siemens. 

Siemens is a global leader in factory automation, rail signalling equipment (the most environmentally friendly form of transport and so critical for reducing emissions in the transport sector) and it sells energy efficient building, factory and grid systems to manage power consumption.  

Ex-US listed multinationals like Siemens, Daimler Truck and Saint Gobain, which generate a large proportion of earnings in the US, are an attractively priced way to play the soft-landing scenario.  

 Stock commentary is illustrative only and not a recommendation to buy or sell any particular security.


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28 February 2024
By Alison Savas By Alison Savas 6 min 6 min