Interactive Investor

US results season forecasts and latest trades

30th July 2021 14:16

Lee Wild from interactive investor

Hugh Grieves, co-manager at Premier Miton US Opportunities Fund, explains why this is one of the most important earnings seasons since the recovery began. He also discusses a possible US consumer boom, why US small- and mid-cap stocks should do well, some of his recent trades and overall prospects for the US stock market.

Lee Wild, head of equity strategy, interactive investor: Hello. With me today I’m lucky to have Hugh Grieves, co-manager of the Premier Miton US Opportunities fund. So we’ve got some big results coming up in the US, so what are your thoughts ahead of these big earnings releases and what do you expect to see over the next few weeks?

Hugh Grieves, co-manager of the Premier Miton US Opportunities FundSo this is probably one of the most important earnings seasons that we’ve had since the pandemic began. You know, at the beginning of the pandemic, it didn’t really matter what companies reported, because earnings were a disaster, because the economy was shutting down. Now we’re starting to see the economy reopening again, this set earnings will be particularly important because it gives investors an idea of the trajectory of the recovery and how far and how fast this is likely to come. In particular, looking at sort of particular sectors and particular companies – and the key is going to be, how strong is the consumer? How much companies are looking to invest and capital spending and spending capacity. 

And then, finally, probably the most important thing in this current environment is, a company’s ability to pass on cost increases. Whether those costs increases are raw materials or logistics or labour, those companies which have the pricing power to be able to stick those price increases to their customers without them complaining is going to be incredibly key. And I think you’re really going to see a split in the market between those companies that have the ability to force through prices and those companies which customers are able to push back and say, “No, no, not this time. You’ve got to wait.” Because that latter group of companies are going to see pressure on margins and that’s going to mean pressure on profits. Whereas the first set are the ones that are going to be the winners, not just this quarter, but probably those are going to be the winners for several quarters to come.

Lee: OK. Look, as well as threats to upside progress, there are reasons to be optimistic, but has the benefit of Joe Biden’s stimulus programmes and the economy’s gradual return to normality been fully factored into the prices? Or is there more upside to come for the broader market, do you think?

Hugh: So this is the big question. You know, we haven’t actually got a stimulus package passed through Congress yet, although it’s looking pretty certain that we will get one, and it will come in at around – call it 800 billion or a trillion dollars. And that will be great for the economy, it represents about 5% of GDP, and it’s investment in a lot of things that America needs to spend money on. Not just roads and bridges, but other things as well. So that would be great for the economy. But then, on top of that, you have an even larger amount of money that’s waiting to be spent. And that is about $2 trillion of consumer savings that have built up in people’s bank accounts through this pandemic.

So this recession is kind of unique, probably, in history, and it’s probably the first recession where the consumer has come out of the recession in better financial shape than they went in. Usually, when you come out of recession, people are much poorer, they’ve rundown their savings, they’ve got less confidence. But this time, because of all the stimulus checks, because of all the furlough schemes, payroll protection schemes and all the rest of it, consumers have received more money through the recession and then been not able to go out and spend any money because of all the lockdowns.  So you haven’t been able to go on holiday or buy clothes or spend money on going out.

So this sort of double whammy, if you like, has meant that, as I said, the consumers have built up these $2 trillion of savings, which is twice the size of the stimulus package. And it represents – to put it – 2 trillion sounds big number – it’s about $15,000 per household, on average.  So that just gives you an idea of scale. So the big question now is, how quickly that money gets spent.  It won’t all get spent at once. There is no way the US economy could handle that amount of spending at once. But if it gets spent out a bit – call it a quarter this year, a quarter next year, a quarter the year after – that’s going to provide a great tailwind for GDP growth for the next couple of years. And I think that’s probably the big thing that is probably misunderstood or under-appreciated by investors, is how good a position the US economy is right now.

Lee: Well look, a key attraction of Premier Miton US Opportunities Fund is its ability to own smaller, less well-known US companies. So why is this so important to investors? And what’s the portfolio’s current split between large and small or medium-cap stocks?

Hugh: Right. So most people invest in US funds, invest in S&P 500 trackers or funds that aim to beat that index. And what many of them may not realise is, the top 250 stocks of that index make up about 84%, 85% of the total value. And in fact, five stocks make up about a quarter of that. So you’re really only investing in the very largest companies in America, which at times may be great. But remember, I mean, there are more than 3,000 companies to invest in in America, once you go down the market cap spectrum. And many of those are wonderful, great companies that are great investments. But if you invest in the S&P 500-type funds and trackers, you ignore all of those businesses, and you ignore all those opportunities.

So by having a fund that can invest throughout the market cap spectrum, we can allocate capital to all of those businesses, which gives us much more shots on goal, if you like, to achieve good investment returns, rather than just focus on the very largest companies. And that’s especially important right now where you’re in a position where, as I said before, the US economy is accelerating. Because it’s many of those smaller companies that are the most exposed or the most focused, or have most to benefit from the improving economy. So in terms of where we are with the fund right now, we’re probably as skewed as much as we’ve ever been towards mid and smaller companies.  

You know, it’s a bit of a moving target. What’s a smaller company in America? Because obviously, different countries have different ideas. One of the common definitions of smaller companies in the US is, any company in the bottom 20% of the market by value. Which sounds fine, but then you do the numbers and it’s all companies with a market cap below $22 billion. Which, when I speak to my colleagues who invest in the UK, kind of laugh, because obviously, that’s a big, big company. But when you look at it in the context of the US where Apple or Microsoft is $2 trillion, you know, $20 billion is like 1% of that. So if you take that definition, we’re already, I think, two thirds – 70% – in smaller companies in the US.  Right from $20 billion down to $3 billion or $2 billion companies.

Lee: I mean, how often do you adjust the portfolio? And could you give us some examples of what you’ve been buying and selling recently.

Hugh: Sure. So we don’t change the portfolio very much. I mean, if we start the year with, say, 40 stocks, 30 of those stocks will still be in the portfolio at the end of the year. So only 10 will come in and 10 will come out. So the turnover is very low.  We want to buy stocks, we want to buy stakes in companies that we can hold for a very long period of time.  In terms of stuff that we’ve been doing more recently, one company we added is a chemicals business called H.B. Fuller (NYSE:FUL), that is the second largest manufacturer of adhesives in the world. Which sounds really dull and boring, and if I’m honest, it is pretty dull and boring, but it’s a great business. Because once you’re specced into a manufacturer to provide that adhesive, you’re probably going to keep that contract for the life of that product, because of the cost of shifting it is so much.

It gives you tremendous pricing power. So when HP Fuller is experiencing increases in their raw material prices, because of higher crude oil prices or higher ethylene prices, they’re able to pass that straight through to the customer. And of course, the customer can’t do without the product, and the customer doesn’t want to go through all the hassle of re-speccing it because it’s such a small part of the total bill of materials. And so the price increase just gets waved through. So they’re in a tremendous position to benefit from doing something really dull and boring, but it’s actually really, really important and really hard to replicate. Which, in this current environment where prices are going up all the time, is really important.

Lee: So how optimistic do you feel about prospects for the fund, compared to previous years?

Hugh: So it’s really interesting, a really good question to ask, because when we started the fund eight years ago, we were asked, “Under what circumstances would the fund have a tougher time or  do less well?” And we said, “Look, there are two scenarios in which case we’ll have a bit of a mountain to climb.” And what we said was, look, if a small part of the market goes sort of Nifty 50, where valuations don’t matter and a bunch of large-cap stocks, valuations go to the moon, we won’t be chasing those because we have a big focus on capital preservation. And the second scenario we said was, if we have an environment where mid and small caps do significantly worse than large caps, then as a multi-cap fund, we will always have some weighting, significant bias towards mid and small caps and greater than everybody else. That will also create problems for us and a hill for us to climb.

Well, guess what? Up until a year ago, we had had nothing but eight years of mid and small caps underperforming and we’d have the FAANGs scenario with valuations going nuts, which we’d pretty much been avoiding. So despite all that, we managed to deliver good risk-adjusted returns for clients. But now what we’re seeing in the last 12 months – and we think it’s going to carry on from here – is, those mega-cap stocks are starting to underperform and they’re not really driving the market anymore. And we’re also seeing mid and small caps start to outperform. And I think both of those two trends – that obviously have been a big tailwind for us for the last 12 months – will carry on from here as the economy continues to expand at a healthy rate.

Lee: Great. Interactive Investor is campaigning for greater transparency regarding fund managers’ investments in their own funds, so skin in the game. Do you invest in your own funds, Hugh?

Hugh: Absolutely, and I think it’s great. I think fund managers should declare, and I can’t see a reason why you wouldn’t want to invest in your own funds. I mean, it’s the group of companies in America that I have the most conviction that anybody should be owning right now, so why wouldn’t I put most of my money in my own fund?

Lee: Absolutely great to hear. Look, Hugh Grieves, thank you very much for joining me today.

Hugh: Thank you, Lee.                                 

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