The much-anticipated Septaper by the US Federal Reserve turned out to be a fizzer. Bonds, equities and the Aussie dollar all performed well upon hearing the news. For now, the guessing game on policy moves continues, though it will be interesting to see how asset classes fare when the pressure in the liquidity hose eventually gets turned down.
At this juncture, we still favour unhedged global equities but remain mindful of the potential impacts once the withdrawal process gets underway. Simply put, investors will need to be more discerning as conditions graduate from a liquidity-driven market to an earnings-driven one.
First advantage
It is important for investors to find companies that can demonstrate sustainable earnings acceleration and recognise this growth before the market does.
Historically, markets have been notoriously poor at spotting inflection points in the performance of a company as well as recognising the full extent of the likely improvement. While behavioural biases explain a number of these inefficiencies, the perception gap is something that can be exploited when valuations lag actual progress.
Many factors can drive earnings improvement. While some are temporary, such as currency fluctuations or accounting adjustments, others are more enduring in nature. A new management team or secular shifts in technology or industry are just a few examples. Yet amid such change, investors are typically anchored by most recent performance and entrenched in conventional wisdom.
Aerospace case study
A good example is the commercial aerospace cycle. The mere suggestion typically conjures the rule of thumb that owning an airline is one of the worst investments you can make. Indeed, a history of Chapter 11s in the US aviation industry and the recent poor performance of Australian carriers validate this very notion.
However, there is a big difference between an investment in the original equipment manufacturer-aerospace cycle and an investment in an airline operator.
As new carriers emerge and old fleets require replacement, orders for new aircraft are currently exceeding annual output. In fact, demand is so strong that the combined order backlog for Boeing and Airbus is currently greater than seven years. With fuel accounting for more than 50 per cent of an airline’s running expenses, next generation aircraft with dramatically improved fuel efficiencies offer significant cost savings.
A specialist company such as Precision Castparts is one of the more attractive ways to invest in the aerospace cycle: it is a manufacturer of complex metal components and products for critical aerospace applications and has significant revenue content across the major aircraft programs including the Boeing 787 and Airbus A380. The company has demonstrated a long track record of growth and enjoys some of the highest margins and capital returns in the aerospace universe. With over 34,000 aircraft deliveries expected over the next 20 years, Precision Castparts has the product portfolio and competitive positioning to be a long-term beneficiary.
Sustainable earnings growth is an invaluable tool for investors and in the event of any unexpected turbulence, companies with enduring growth characteristics should help keep portfolios in an upright position.
Patrick Noble is a senior investment strategist at Zurich Financial Services Australia.
