The Bloomberg U.S. Economic Surprise Index has dropped below zero for the first time since the U.S. presidential election. This measure can be seen as an indicator of accelerating or decelerating economic growth (in the U.S.). Simply put, many expected too much, too quickly following the U.S. election, and we expect company-specific earnings developments to drive stock returns in the near future.
According to a recent Wall Street Journal article, a combination of decreased geopolitical risk, lack of fiscal policy guidance in the U.S., and global quantitative easing policies from central banks, has prevented volatility from increasing worldwide, despite steady returns from equity markets. This has created an environment where investors are pursuing volatility and higher risk (hoping for returns) in complicated instruments including digital currencies. However, despite being used for speculation, there are some legimate secular tailwinds for digital currencies (and the technology behind them) that go beyond pure momentum including potential acceptance by main-stream finance services companies and skepticism about the potential manipulation of government-backed currencies by central banks worldwide.
The MSCI’s inclusion of Chinese shares in its Emerging Markets Index could lead to changes in the governance of Chinese companies as international investors require them to conform to international standards. The reaction by institutional shareholders and research groups has been mixed, as there is a debate regarding the ability of companies to reform given the political influence still present in China. Ideally, an increasing acceptance of global standards by Chinese companies will help investors more accurately value assets.
The recent volatility in some small-cap shares listed on the Hong Kong stock exchange highlight the importance of understanding the underlying fundamentals of the investments owned in a portfolio. Activist investor David Webb highlight the risk to many of these companies stemming from cross-shareholdings among many firms, which had elevated valuations beyond economic reality. The lesson here is two-fold, there can potentially be a benefit from fundamental analysis of companies in attempting to uncover company-specific risks and elevated valuations should provide an indicator for investors to re-evaluate the factors supporting current valuations.
Damien Conover, CFA, who is a director at Morningstar, believes that there are five factors contributing to an “economic moat,” by which investors might be able to increase their ability to find discounted companies in the health care sector. Those factors include: intangible assets (ie, patents), cost advantages, the network effect, high switching costs, and efficient scale. Additionally, Mr. Conover makes the argument that an increase in the rate of innovation (as opposed to incremental improvement) has helped the industry increase its pricing power. Morningstar’s conviction in analyzing innovation and competitive advantages, i.e., the economic moat, provide a good description of the type of attributes that are included in fundamental analysis.