One more puff in this bull market?

Perpetual Global Share Fund
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Despite all the volatility that we saw in equity markets last year, it’s interesting to note that you could have invested one dollar in the US S&P index at the beginning and ended up with that same $1 in US dollar terms now. You could have gone into hibernation for a year and woken up thinking nothing had changed. This highlights how important active management is – invest money during market weakness and withdraw it during strength. This is especially the case during the tail end of a seven year bull market, which is where we are today. While I expect similar levels of volatility in 2016, I hope there’s one more puff left in this bull market.


The US economy is improving steadily, despite apparent headwinds

The US economy is improving steadily with GDP growth at approximately 2.5%, wages growing at 2%+ and the unemployment rate close to 5%, which I would deem close to full employment. The strong US Dollar is dampening inflation and weighing down export growth and tourism which is affecting retail sales in tourist areas like New York. Despite this, the economy continues to grow with lending on the up, driven mostly by the commercial sector. We still expect another one or two rate rises in the US this year.

Interestingly, history tells us that the S&P 500 can still advance in the face of rising rates. After the initial rate hikes of 1994, 1999 and 2004, the S&P 500 averaged a gain of 6% in the succeeding 12 months.

We are overweight in US financial and technology stocks and expect them to perform well over the coming few years. As a value investor, we’re still finding plenty of under-valued companies in these sectors and think that too many people are hiding in over-priced consumer staples companies.

Asia: the new China

I recently went on a trip to China, Korea and Japan and continue to believe in the growth prospects for the Asian region. I spent a day in Beijing. In what is bad news for parents – but good news for investors – pollution levels are currently so high that the country has suspended outdoor activities at elementary and primary schools and issued orange and red alerts for smog. The factories that were shut down in late August 2015 to reduce air pollution are back up and running. The weakness that the Chinese economy saw in July to September seems to have reversed in October, with industries like the auto sector seeing a strong pick-up in activity. I met with Autohome and Dongfeng Motor and they were both positive on the outlook for auto sales in China going into next year.

The Chinese services sector continues to grow strongly, offsetting the weaker manufacturing sector. Interestingly 48% of Chinese GDP is derived from the services sector versus 42% from the manufacturing sector. This is why Chinese GDP continues to grow. We like internet companies in China, which are benefiting from structural tailwinds. While retail sales in China are growing at 12%, online retail sales are growing at a much quicker rate.

I’ve written about a company called Zhaopin before. I sat down with company management in Beijing and I continue to gain more and more confidence in the quality of the business and the quality of their management team. They are benefitting from continued growth in the technology, media, telecommunications and financial services sectors in China, which are seeing strong employment growth.

Korea is a market overlooked by many western investors which creates opportunities for value investors like us. We have recently initiated a position in Hyundai Department Store, one of the leading premium-end department store operators in Korea. The company is more like a Westfield than a typical department store, with a mix of luxury goods, cosmetics, women’s and men’s fashion and food. The shops are operated by the brand owners and Hyundai Department Store owns the property and charges a concessionaire rate or rent. The company is controlled by the Chung family, who run the business conservatively with a strong balance sheet. Despite these qualities and sales growth, the company trades at a 20-30% discount to the value of its properties.

It reminds us of the time when the Perpetual Australian equities team bought a large position in Harvey Norman (ASX:HVN) at $1.80 in 2012. The stock was unloved and everyone thought that online commerce would lead to the demise of Gerry Harvey and his business. Three years later, the stock has more than doubled and is trading at $3.80. Interestingly, the price to earnings and price to book of Hyundai Department Store today (Chart 01), looks very similar to the levels that Harvey Norman was trading at in 2012. You can also see in Chart 02 below, how Harvey Norman’s price to book has re-rated over the past three years. It’s quite possible something similar will happen to Hyundai Department store.

Chart 01: Hyundai Department Store price to book value 2006-2015

Source: Perpetual Investments and Factset.


Chart 02: Harvey Norman’s price to book value 2006-2015

Source: Perpetual Investments and Factset.

This article is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. The views expressed in the article are the opinions of the author at the time of writing and do not constitute a recommendation to act. Any information referenced in this article is believed to be accurate at the time of compilation and is provided by Perpetual in good faith. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.

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