Five months ago Ned Bell was rubbing his hands together as he surveyed the scene.
The S&P 500 had dived 12 per cent from a record high in September as a hawkish Federal Reserve and the US-China trade war exacerbated a global slowdown that exposed the vulnerabilities of overpriced tech giants.
By Christmas it was down 20 per cent from the peak.
But after the worst December for US shares since 1931, it was only a matter of time before the Fed would capitulate and the US-China trade rhetoric would improve.
Bell Asset Management’s chief investment officer was preparing to load up on his favourite companies at bargain prices after selling out of Microsoft and trimming long-held tech exposures like Apple, Alphabet, Mastercard and Visa in the third quarter last year.
By year-end, BAM had built up the fund’s cash reserve to the 5 per cent limit allowable under its investment mandate. Then, in the first week of January, Bell pounced on beaten up “meat and potatoes”-type stocks such as Broadridge Financial — which does a lot of the back-office work for the big banks — and Sysco, a distribution company servicing the food service industry.
“In terms of the portfolio in the first four months of the year, we put quite a lot of money to work, literally in the first week of the year,” Bell says.
And throughout the sell-off, Bell held on to and increased his exposure to US consumer plays Starbucks, Lowes and O’Reilly Automotive, the Canadian multinational operator of convenience stores Couche-Tard and US household and personal care group Church and Dwight.
In the year to April, BAM’s Global Equities Fund made an impressive 22.3 per cent return gross of fees versus 14.2 per cent for its MSCI World index benchmark. Half of that 8 per cent outperformance came from small-mid caps.
“In stark contrast to a couple of years ago when the US consumer got crushed by the ‘Amazon flu’ and the market was basically implying that a lot of these companies were almost going out of business, the US consumer is in really good shape,” Bell says.
“One of the biggest issues flagged to us by US companies we talk to is wage inflation and the difficulty of retaining staff, because the jobs market is so strong.”
The latest data shows the unemployment rate fell to 3.6 per cent — the lowest since 1969.
“Most of our alpha (outperformance relative to benchmark) has been in consumer discretionary, consumer staples and financials, of all things — which is a bit different for us.”
BAM had acquired stakes in out-of-favour US consumer discretionary companies in the second half of 2017, and in the March quarter of 2018 it waded into US consumer staples at a time when “they were so unloved and cheap relative to the market, you couldn’t give them away”.
“We added to those bets at the start of the year and that’s really paid off,” Bell says.
The US tech sector, while it has been good for BAM over the years, has done little of the heavy lifting in the past year. BAM does hold companies such as Cisco, Mastercard and Visa that have done well but it hasn’t been a “one-trick pony” driven by “crowding in” to tech stocks.
“We’ve owned Apple for 13 years and we gave it a pretty big haircut in the third quarter — which proved timely — and we also trimmed our other big tech exposures, but we are fairly neutral on them now because we still have concern about this ‘crowding’ in to the biggest tech names via ETFs.”
He also notes a “dichotomy” in the US, where the consumer sector is “really strong” but the industrial sector is grappling with slowdowns in China and Europe.
Indeed, a difficult outlook for cyclical industrials like 3M and Cognex, combined with a swathe of IPO offers from the likes of Lyft, Pinterest, Zoom Video and Uber, has more recently weighed on Bell’s mind.
As the US sharemarket hit fresh record highs in late April, he took profit in several stocks, and in so doing increased the cash reserve of the fund to 4.3 per cent.
“Probably the biggest change we’ve made is just reducing our exposure to industrials and rotating into selective mid-cap stocks — that’s where we still see the most attractive valuations,” he says. “We sold our position in Siemens and a couple of small to mid-cap industrials. The reason we pared back our exposure to the industrials is that the macroeconomic backdrop is obviously deteriorating, especially outside of the US.
“We don’t own it, but 3M had a pretty rough result. They called out weakness right across all their divisions and most geographies. For what’s regarded as one of the more well managed and diversified industrials, they took a pretty significant beating.”
A build-up of inventories in the first-quarter US GDP data was another warning sign, European growth has continued to soften and earnings guidance from cyclical US industrials related to factory automation, such as Cognex, has disappointed.
Earnings outlooks for US companies compared with a year ago — when tax cuts had just been implemented and growth was accelerating — are getting tougher, and Bell now sees an earnings cliff for some industrials where consensus earnings estimates are likely to prove overly optimistic.
Overall, Bell sees resurgence for active funds management.
“I think when Jay Powell (the Fed chair) looks ahead, he sees quite a bit of uncertainty, and the rekindling of the trade war flames this week is just a reminder of that.
“We think in the next three to six months there will be a lot of opportunities to buy great companies that will play out in the next few years.”