Focus on earnings, valuations amid economic uncertainty

The global economy continues to navigate a complex post-pandemic macroenvironment, which is a key element driving global equities.

“Clearly, we have been going through a bit of a transition over the last couple of years,” said Murdo MacLean, client investment manager with Walter Scott & Partners Ltd. in Edinburgh, Scotland, in a recent interview.

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“From the Covid environment into the sort of rebound higher inflationary environment and then into something now where it appears as if the battle against inflation is being won,” he said.

But economic uncertainty persists.

“There are question marks around the direction of travel for the global economy — whether we will dip into recession or whether we will avoid that,” MacLean said. “And, of course, that will differ by country.” 

U.S. Federal Reserve monetary policy will have “a ripple effect on other central banks and sentiment more broadly,” he noted.

And geopolitics, such as U.S.-China relations, is another macroeconomic factor to consider.

“You have two economic powerhouses, one seeking to preserve their position at the top of the order, and the other one seeking to challenge that,” he said. Industries such as semiconductors could be particularly vulnerable. 

Beyond factors such as monetary policy and geopolitics, a more important long-term determinant of equities performance is corporate earnings and valuations, he said.

“In light of the fact that many of the other factors are out of our control, [earnings] is the key area we focus on,” MacLean said. The “long-term overarching driver for equity markets is earnings at the company level.”

He has his eye on several sectors that may offer opportunities, though they still reflect “a softer economic backdrop.”

For example, “health care, which we know to be a long-term growth sector because of the supporting demographics, has been quite patchy,” he noted.

He named Lilly and Novo Nordisk as examples of companies that have capitalized on growing demand for obesity treatments. However, other areas such as biotechnology and medical devices have faced a “bumpy ride,” he said, due to post-pandemic bottlenecks and higher capital costs.

The industrial sector has also softened over the last couple of quarters, he said. Railroads, for example, are “a bit of a proxy” for the North American economy.

“Old Dominion Freight Line — ODFL — which we also know well, again, will reflect the health and the confidence of the underlying economy and the participants within that,” he said.

Longer term, health care and industrials will play an important role “in what are growth industries and are at the forefront of innovation,” he said.

The consumer space has also seen “a general weakening,” he said. 

Though companies like Costco and TJX Companies (parent of T.J. Maxx and Marshalls) continue to perform well, high-end luxury brands are seeing a cooling trend.

“That’s probably to be expected, given that we saw really strong consumption patterns in luxury post-pandemic,” MacLean said. Likewise, the outlook for travel names is uncertain, he said, citing Booking Holdings Inc. and Expedia Group Inc.

MacLean also warned of high valuations.

“We must be cautious around businesses that are trading on valuations that historically look high, and then take care to analyze what it is about those valuations, what is driving those valuations to be so high,” he said.

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