Profit Boom Imminent In 2010

Profit Boom Imminent In 2010

Canny investors should look to capitalise on an imminent corporate profit boom this year, says a leading fund manager.

New Zealand Assets Management director Alan McChesney says a “profit explosion” in the US is potentially 2010’s big surprise.

“US businesses have used the sharp downturn to slash costs – especially in labour – and are now running lean and hungry enterprises with strong cash flows where any increase in revenues will be directly translated into profits.

“While many commentators have expressed the view that this cost cutting will have a one-off short-term benefit, they miss one critical point – businesses will be able to hold off increasing overheads for quite some time, only adding staff when it is absolutely necessary to do so. This will lead to a very large labour productivity gain for the US economy for some time.”

Mr McChesney said US businesses are generally in good health, primarily because they have not carried significant debt into last year’s carnage.

“Low interest rates and ample liquidity in the new millennium gave these businesses the opportunity to aggressively restructure their borrowings and reduce debt, having been burnt by overinvestment decades earlier.

“Having finally manoeuvred themselves into a much stronger balance sheet position, these companies were reluctant to chase the cheap money that was around prior to 2007.”

As the world remains very much US-centric with global equity markets taking their lead from the performance of the US, this should augur well for the performance of global sharemarkets, said Mr McChesney.

“Some may argue that the S&P500 equity index is now fully valued, but this misses the key point that 2008’s rally has been driven by stocks that are now clearly overvalued.

“In the meantime there are many quality defensive stocks such as Coca Cola and Proctor & Gamble that have not participated materially over the last 9 months and remain particularly attractive on any valuation basis.”

Mr McChesney said this latter group of defensive stocks would be the main beneficiaries of the profit boom.

“Not only have they cut costs, but many of these businesses derive a sizeable portion of their revenues from emerging markets such as China where the economic recovery is now well underway.

“Higher profits, stronger cash flows and the ability to access cheap credit should lead to an economy that is driven by a significant uplift in corporate capital expenditure through increased merger and acquisition activity, renewed capital investment on R&D, and new productive capacity in the form of new plant and more jobs.”

He said the second part of the US recovery should come from the export sector where the weak greenback places US companies in a very competitive position relative to the rest of the world.

But he cautions that a surprise US profit boom should not be confused with a strong global economic recovery from the Armageddon of 2008.

“While many economic indicators are looking slightly rosier with some countries like China and Australia already returning to positive growth, unemployment continues to worsen and governments in developed economies like New Zealand’s will have to wear budget deficits that may well be a legacy for a generation or two to come.

“Question marks also remain over the quality of the stocks that have driven the equity market rally in 2009 – something a number of our fund managers have appropriately referred to as the ‘trash rally’, which is a reflection of their unattractive underlying fundamentals.

“A near perfect global economic outcome would be needed to justify their current pricing – something which suggests that these stocks may be vulnerable to a correction that will impact significantly on the indexes.

“While we should not expect a strong economic recovery, there are a number of good reasons for canny investors to seek some targeted sharemarket exposure.”

About New Zealand Assets Management

Established in 1991, New Zealand Assets Management is a globally-focused investment management firm. Based in Auckland and Wellington, NZAM uses global equities strategies with the emphasis on providing absolute returns on clients’ invested capital.

This strategy has delivered annual compound returns of 10 per cent per annum, and annualised returns in its 18-year history are 4.8 times the international benchmark MSCI World Index (in NZ dollar terms).

It also manages an Asia and China-focused fund denominated in USD and Euros.

ENDS

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