Invesco Canada blog

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Jim Young | November 6, 2012

U.S. companies: Stronger, better managed and more resolute

After a very difficult decade, U.S. equities reached a low point in March 2009, the result of rising deficits, wars, government intrusiveness and poor financial regulation of real estate and mortgage-related assets. Investors simply lost confidence in American institutions.

Because confidence plays an essential role in any long-term valuation framework, the appetite for, and valuation of, U.S. equities declined.

But despite the difficult environment, many U.S. companies continued to work hard to make their businesses more efficient and effective. They also redoubled their efforts to capture opportunities around the world, particularly in emerging markets.  They put in place new technology to help them manage the business more effectively on a global basis and to speed product development.

Many companies were very successful in these endeavours and, as a result, they were able to grow their businesses at an attractive rate and even add to their already formidable financial strength and capabilities. Many multinational companies now have the predominant share of their business outside of the U.S. and have therefore reduced their dependence on any one region.

Today, they have more control over their destiny than at any other time in history.

The overall lack of confidence, which still persists today despite recently improving equity returns, has caused investors to become excessively risk averse and short-term oriented. As a result, many have allocated most of their capital to very low-risk assets such as Treasury bonds and any forays into equities are best characterized as short-term trades.

Just as excessive enthusiasm for any asset class is usually not rewarded, neither is excessive caution. There is potential today to exploit the fear and short-term thinking influencing investor behaviour by looking to the future with confidence.

Confidence in the ability of well-positioned U.S. companies to provide attractive returns seems to be justified given that these are among the strongest institutions in society today. They are stronger, better managed and more resolute than most government bodies around the world. They will also be among the largest beneficiaries of rising consumer confidence that will occur as governments begin to scale back commitments, reduce deficit spending and adopt a more pro-business attitude, which is inevitable, particularly in the developed world.

There are many opportunities in the world today:

  • Technology companies continue to impress with exciting new products that provide enjoyment and enhanced efficiency
  • Surprising energy developments in the U.S. are likely to lead to energy self- sufficiency, which in turn seems to be driving an incipient reindustrialization
  • Infrastructure needs to be rebuilt in much of the developed world and put in place for the first time in emerging nations
  • Reliable financial products and trusted institutions are much needed after the debacle of 2008 and 2009 and large market share opportunities exist
  • The rising middle class around the world can now afford many of the products that have become essential to our way of life and this is the biggest opportunity in history for global consumer products companies

This confluence of corporate strength, investor skepticism and an opportunity rich environment is the type of scenario that could prove very rewarding for confident investors.

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11 responses to “U.S. companies: Stronger, better managed and more resolute

  1. Hi Greg,
    The problems we are faced with are serious and they have developed over a long period of time. It will take many years and serious effort to begin to fix the root causes of the problems. We have reached a point where the problems must be addressed – borrowing capacity is maxed out and can no longer be used to fund social programs. That is what all the debate in the developed world is about and that is why there is no confidence in government institutions. Policies do make a difference to the economic climate but they are not the only determinants.
    There are 7 billion people in the world and every day more people are participating at a higher level. The pace of innovation is rapid and every advance brings with it the potential for job creation and wealth creation. These in turn bring consumer spending and tax revenues.
    This is happening despite the negative impact of poorly conceived government policies.
    The US is a wealthy nation – over 50 trillion in net worth – after all the debt is paid. There is adequate capital to fund investment opportunities. Investment is, however, occurring at a slower pace than if we had proper policies – but it is nonetheless still occurring. If we begin to move toward a better balance between private sector investment spending (more) and government social spending (less) then confidence will build, the pace of economic growth will accelerate and capital will flow (perhaps rapidly) out of defensive instruments and into equities – a potentially massive shift.
    One of the reasons the market may be struggling higher in the face of all this turmoil is, perhaps, that many of the leading S and P 500 companies are some of the strongest institutions in society today – with fortress-like balance sheets and a global reach, enabling them to pursue opportunities anywhere in the world, not just the developed world.
    Perhaps too, some savvy investors realize that the pressure now for change is so great that logically it will begin to happen.
    It is also important to recognize that excesses are rarely rewarded in the investment world and currently I see an excess of caution on the part of investors.

  2. Hi Jim,
    I’m having some difficulty in sharing your optimism. It seems to me that investors are entirely justified in losing confidence in US institutions. In large measure we are currently in the midst of economic/financial mkt ‘smoke and mirrors’ in history.
    Whether you look at things from a micro or macro perspective, it is irrefutable that the picture is massively distorted by at least 2 trillion per yr in unprecedented Federal deficit financing and the (again unprecedented) Bernanke printing press. Similar distortions are taking place in virtually all of the worlds developed economies. the net result is a US economy barely operating at stall speed.
    The only thing US lawmakers can seem to agree on is that the current course is unsustainable and that the fiscal cliff must be avoided at all costs because the economy is too fragile to withstand it. The math of the fiscal cliff is a combination of tax increases and spending cuts which would reduce the Federal deficit by $600 billion in the coming yr. Pardon me for pointing out that even if it were to happen, it would still leave a deficit which would have been record in any yr previous to Obama. No doubt they will find an agreement that will back end load the medicine which is inevitable without actually doing anything constructive right now. In the meantime the gigantic debt hole gets even deeper and harder to ultimately address.
    As to the equity markets, it is hard for me to reconcile a rising S&P against a backdrop where there has been a net withdrawal of cash since the 2010 ‘flash crash’. I understand that there has been in excess of $500 billion withdrawn from the equity market over the last couple of years. For virtually all of my career there has been a very high correlation between the market trend and the dollar value traded. Since 2009 that correlation has been broken–the dollar value traded is declining even as the S&P trends up. One has to wonder whether the High Frequency computers are ‘wash trading’ the mkt higher with the help of Bens free money machine. Certainly, the old saying of ‘trend follows volume’ doesn’t apply in the current market.
    It amazes me that the financial community is so sanguine about the end result of the policies that are being pursued. The same group of people who led us to the edge of the precipice in 2008 are now using the very same tools in an ultra format to rescue the situation. Rolling back FASB157 and providing free money to the top of the financial pyramid serves only to kick the can down the road while making the underlying problem even worse. Running a consumer based economy while the middle class is being decimated cannot end well. Please convince me I’m wrong.

  3. Hi Jo-Anne and Rizwan, thanks for your comments. The fiscal cliff is an artificial construct representative of the politicization of the allocation of resources in society. Ideological differences exist between the two parties with respect to the appropriate balance between social spending and economic investment and also with respect to whether capital is best allocated by the private sector or by government. Each side needs to make concessions to arrive at a solution and, although a middle ground is relatively apparent to most observers, there will be a great deal of wrangling before we get there.

    With respect to long term economic potential, the fiscal cliff drama is an unfortunate and unproductive sideshow. The reality is that fundamentals in the U.S. and many parts of the world are already pretty good or getting better. The rise of the middle class globally is consequential for many companies, technology continues to advance at a rapid pace, health care advances are accelerating, energy self-sufficiency looks probable in the next few years in the U.S., which may spur a manufacturing boom, and the housing sector is recovering, which will fuel job creation and retail sales.

    The distraction in Washington serves only to temporarily lower equity prices, providing an opportunity for alert investors. The companies we own in the portfolio have been selected in part to capture the most important investment opportunities that should play out over the next decade.

  4. Can you comment on the US fiscal cliff? What does it really mean? How will it affect global economies and stock markets?

  5. Currency movements are difficult to call in the short run, hence we have hedged and unhedged versions of the fund. Longer term, currencies reflect the underlying strength of the economy. The Canadian economy is driven primarily by the resource sector, manufacturing and financial services. The strong dollar has eroded the manufacturing sector and recently commodity prices have weakened. Our economy is becoming more narrow over time, which increases the risk. We would characterize this as an negative development for the Canadian dollar.

  6. Our thesis on an improving equity market in the US is premised on 1) a strong corporate sector able to take advantage of opportunities around the world as a result of their considerable financial and operational strength; 2) political change such that deficit financing of open ended entitlements is curtailed and a more balanced, sustainable framework is put in place that encourages private sector investment. It is not apparent that the reelection of Obama advances this second requirement and therefore appears to be a negative development. If he moves to a more centrist position and crafts a comprehensive solution with the Republican Congress then this requirement would be met.

  7. David, as former shareholders of BB&T we know John Allison well and have a great deal of respect for his insights and opinions – they are invariably balanced and rooted in fact. His chronology of events is accurate. Government overreach can be a serious issue and generally brings with it unintended consequences. In this case, the effort to change the essential character of assets and liabilities led to reduced transparency and altered perceptions of risk, which proved destabilizing. Our investments in the financial sector are focused exclusively on companies with strong credit cultures, careful capital allocation and prudent growth strategies. As a result, we think they are in a position to withstand the fallout from external events.

  8. I hope the manager is able to address currency correctly as it’s potentially going to be very volatile for our Cdn $ clients.

  9. Jim, I have studied the financial crisis quite a bit and just completed John Allison’s (just retired head of BB&T Bank) book “The Financial Crisis and The Free Market Cure”. He identifies a long series of controls/regulations that caused the crisis: a) the government mandated Fed inflated the money supply and lowered rates; b) money flowed into real estate due to government rule about interest deductibility and government requirements for lending to sub-prime borrowers; c) weak debt products were created by the intrusion of government sponsored entities Fannie and Freddie; d) the debt was spread worldwide by securitization and weak risk rating by government mandated ratings agencies; e) when the risk was recognized and prices started to fall, financial institutions saw their capital erased by government required mark-to market accounting; f) when some banks failed, arbitrary intrusion by government froze the market capital and left investors with no confidence that rational markets would exist; g) government forced TARP ont he market and further clouded everything.

    Almost no one identifies this series of causes and integrates them all inot a full picture. I’d appreciate any comments you have in the above.

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