As an investor in US equities, I am of this latter opinion. While growth momentum has undoubtedly weakened during 2011, the US market remains better positioned than most to negotiate further volatility and fluctuating sentiment. While it is now almost universally accepted that the US economy has entered, or is about to enter, a recession, we continue to believe that this is not the case and, even if it does occur, we think it will be shallow in nature. On a stand-alone basis, the US economy remains soundly underpinned – a position very different to the one that existed towards the end of 2007. Real interest rates are negative and credit is becoming more readily available, albeit at a watchful pace. All these factors point to the economy continuing to grow in the final quarter of the year. There remains significant pent up demand and we believe we are in the early stages of this demand being unlocked. Meanwhile, at the corporate level, US company profitability remains at historically high levels. Deleveraging has been a feature and balance sheets are flush with cash, providing companies with greater resilience to any shocks that might arise from a dislocation in the financial markets.
The Europe effect
The biggest risk to our positive outlook revolves around the eurozone and the potential impact that sovereign debt defaults would have on the global banking system and credit availability. As witnessed in the 2008 downturn, credit availability is the single most important factor that drives economic cycles. To date, however, our forward looking credit indicators remain positive (although less so than in prior months as there is clearly some risk aversion developing in the European banking sector). The situation bears close monitoring, but does not yet appear serious enough to cause an outright recession in the US. Meanwhile, there are more local risks and concerns. Having already lost its coveted AAA rating, the recent failure of US Congress to agree a plan to reduce the nation’s $15 trillion+ budget deficit (triggering $1.2 trillion in automatic spending cuts from January 2013) creates further uncertainty.
Growth potential
Against such a backdrop, we expect the AXA Framlington American Growth Fund to continue to deliver solid performance during 2012. The Fund strategy reflects our central belief that, over the long-run, companies that have good, open-ended growth opportunities, high quality management, and the capital to maximise those opportunities, will provide superior returns for investors. Accordingly, we look for companies displaying above average revenue and earnings growth. Identifying unit driven, secular revenue growth (rather than cyclically driven growth) companies, with strong balance sheets, is a key objective, whilst avoiding companies which grow their earnings primarily through cost-cutting and financial restructuring.
Given the focus on identifying superior growth prospects, we typically find the kind of stocks we are interested in within the consumer discretionary, healthcare, industrial and technology sectors, and are overweight accordingly. True growth companies are much harder to find in the more defensively-oriented sectors such as consumer staples, utilities, telecom services, financial services and basic materials, as they tend to be heavily reliant on the state of the economy or, indeed, are already fully mature and lack the innovation and new product development that drives growth.
Given the focus on long-term, secular growth, the Fund is inherently well exposed to mid cap companies. We are trying to identify those companies that are in the process of becoming the large, market leading names of tomorrow, rather than those companies already there. At the same time we maintain a strict discipline of not investing in unproven or illiquid small cap names.
With credit availability far harder to come by, we believe that earnings growth will be a scarcer commodity going forward and this should support the relative performance of growth stocks. Low interest rates should also enable the earnings multiple awarded to high quality companies to expand, resulting in outperformance for the growth style applied in our Fund. Furthermore, the mid cap growth stocks that the Fund holds remain at historically low valuations, versus their more cyclically-driven, value counterparts.
Stephen Kelly is Manager of the AXA Framlington American Growth Fund.