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By Prabha Ram, CFA - April 2019
I see the economy as a three-legged stool: one leg is consumer demand; another is the influence of U.S. Federal Reserve policy; and the third is business fundamentals. And while the first two are critically important, my team and I tend to focus more on that third element—business fundamentals—and work to find companies that can compete and grow sustainably in any part of the economic cycle.
We experienced an impressive rebound in the first quarter of this year, especially considering how equity markets experienced a sharp fall in Q4 2018. And while I envision continued growth this year, I think it will be slowing a bit.
There are a couple of related issues that worry me: the first is the flat and in places inverted yield curve, and how it historically has been a potential indicator of economic headwinds. The second is the difficulty of banks to make money in a low rate and flat curve environment, by constraining the availability of credit.
Check out my latest quarterly video to find out more on those two topics and much more.
After a very good start to 2019, we are looking forward to investing in robust growth, innovative companies with secular growth, which will navigate any prevailing market conditions and even benefit from them.
We think of market direction as a three-step process—think of it as a three-legged stool. So, the first leg would be consumer demand, if you will. If you look at GDP (gross domestic product) growth, we’re coming off a very good year in 2018 at 2.9%. It’s expected to step down a tiny bit to 2.2%, but it’s still very healthy.
Now, the second leg of the stool, if you will, is the Federal Reserve (Fed). And that has been a U-turn since Q4 of last year. So, they’ve gone from what was a tightening stance to what is an accommodative stance. The median was a projection of two rate hikes in 2019. Fast forward to March, and it’s zero hikes in 2019.
The third thing in which we focus on is business fundamentals. So, an accommodative Fed is good for businesses. And as we look at earnings per share growth expectations for 2019, it’s off of the highs of 2018—that was 21%. But remember a third of that was tax reform in 2018. 2019 is more modest but definitely there is still growth.
The one other factor is the yield curve and how flat is has become, and even inverted at times. There has been a lot of press around this. And yes, it has been an indicator of headwinds and slowdowns, historically. So that’s something we do watch out for. But if you think about all the things I just talked about, we’re looking at a slowing but still a robust economy.
However, what is more concerning is the ability of banks to make money in this environment, and that slowing down the economy. Banks, as you know, make money by taking in deposits and making loans that are much higher duration. In this environment where the curve is flat, the ability to make those loans is not profitable. So, if they were to make the economic decision and stop making loans or slow down the growth of credit, that could slow down the economy and that’s one thing that we monitor and are concerned about.
However, as Q1 has shown, the accommodative Fed has been good for markets. And we’ve seen 13% growth. So, we will continue to monitor the headwinds, but it looks like it’s a reasonable environment for stock pickers.
As we look at investments for the rest of 2019 and our holdings at this point, we focus on companies that have sustainable growth in their mix. That would be because of innovation, because of their execution, and network effects, as well. Those are the ones that we focus on, and we are confident that they will do well in 2019.
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Portfolio Manager Prabha Ram is focusing on companies that have sustainable growth in their mix as she looks at investments for the rest of 2019.
Portfolio Manager Prabha Ram is seeing a mix of good and bad economic indicators heading into 2019. Where is she finding opportunities in the noise?
January 23, 2019
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