Investment View: Why slow growth is not troubling equities

Cost-cutting, productivity improvements and restructuring cannot be repeated endlessly

While economic growth and corporate earnings disappoint, stock prices have recorded strong gains. In 2012, the MSCI All-Country World index of equities increased 16.9 per cent including dividends. The US S&P 500 index increased 13 per cent, the most since 2009.

The German economy slowed, recording only marginal growth, yet the DAX rose 29 per cent. France performed even worse, but the CAC 40 rose 15 per cent. Despite the fact Italy faced serious economic problems, the stock market rose 8 per cent. While Spain tottered on the edge of a bailout, stocks fell a modest 5 per cent.

The phenomenon extended to emerging markets. Although India's economy stagnated, the Sensex index increased 26 per cent. The South Korean and Brazilian stock markets both rose as growth slowed. Argentina's stock market grew 17 per cent despite its dysfunctional economy.

Changes in the economic environment have altered the dynamics of stock markets. Macroeconomic factors, slowing growth and especially policy measures such as the global regime of zero-interest rates and quantitative easing colour most markets, driving the valuation and performance of firms.

Profit margins and cash flow improve, perversely, in a period of low growth. Initially, companies cut costs, improving profitability. As revenues are stagnant, companies have no need to invest in expanding capacity or working capital, releasing cash flow. Reduction in depreciation charges and the ability to use cash flow to cut debt reduces interest expenses.

In the present cycle, sharp decreases in interest rates, though not necessarily interest margins, have also improved profit margins. But plant must eventually be replaced. Cost-cutting, productivity improvements and restructuring cannot be repeated endlessly.

In the long run, increases in profitability require revenue growth. But lower growth translates into lower demand, slowing revenue increases.

Lower demand and also overcapacity in many industries have reduced corporate pricing power, decreasing profitability.

A striking feature of recent corporate history has been low and poor-quality revenue growth. Earnings have increased more than revenues. Where companies or sectors experience revenue growth, the causes are interesting. Those on the receiving end of government spending targeted at increasing demand have benefited. Artificially low interest costs have encouraged substitution of technology and mechanised equipment for human resources, boosting revenues of technology and industrial equipment manufacturers.

Commodity producers' revenues have benefited from rises in volumes and higher prices. Some firms have increased revenue by cannibalising competitors and adjacent industries.

The build-up of cash on corporate balance sheets is frequently cited as a sign of corporate health.

In the US, since 2008 companies have been net lenders rather than borrowers and now hold around US$1trn (£622bn) in cash. Japanese companies hold liquid assets of $2.8trn. European companies also hold large cash balances. Mark Carney, the newly appointed Governor of the Bank of England, referred to the $300bn of cash held by companies in his native Canada as "dead money".

Cash surpluses affect stock prices and returns. Many companies have returned capital, through stock buybacks and higher or special dividends. In the US, fear of tax changes has also been a factor. But investors are now faced with the problem of where to deploy the cash.

Other companies have used surplus cash to purchase competitors, businesses or assets. Given the indifferent results of many mergers and acquisitions, it is unclear that this will benefit anyone other than shareholders of the acquired company and investment bankers.

Changing demographics affect stocks. Investors approaching retirement may switch to more defensive asset and seek steady income, favouring bonds and cash. Low and declining returns over time have also undermined demand for equities. The reduction is evident in outflows from equity funds into other assets.

Low interest rates have driven stock prices. Dividend-paying stocks have benefited from the attention of investors seeking income. Algorithmic trading now dominates stock markets, making up between 30 per cent and 70 per cent of all activity. Computerised trading may increase volatility. Revelations of insider trading also undermines investment interest, especially from retail investors.

These changes make valuations based on history more difficult.

The American comedian Will Rogers provided sage advice about investing: "Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it."

Fundamental changes in the drivers of stocks and trading in equities now make Rogers' views on investing success more important than ever.

Satyajit Das is a former banker and the author of 'Extreme Money' and 'Traders, Guns & Money'

News
peopleFrankie Boyle responds to referendum result in characteristically offensive style
News
news
Life and Style
Couples have been having sex less in 2014, according to a new survey
life
New Articles
i100... with this review
PROMOTED VIDEO
Voices
Holly's review of Peterborough's Pizza Express quickly went viral on social media
Sport
footballTim Sherwood: This might be th match to wake up Manchester City
Arts and Entertainment
musicHow female vocalists are now writing their own hits
New Articles
i100
News
ebooksAn unforgettable anthology of contemporary reportage
News
news
Arts and Entertainment
musicBiographer Hunter Davies has collected nearly a hundred original manuscripts
News
Blahnik says: 'I think I understand the English more than they do themselves'
people
Arts and Entertainment
Michelle Dockery as Lady Mary Crawley in Downton Abbey
TVInside Downton Abbey series 5
Life and Style
The term 'normcore' was given the oxygen of publicity by New York magazine during the autumn/winter shows in Paris in February
fashionWhen is a trend a non-trend? When it's Normcore, since you ask
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Senior BA - Motor and Home Insurance

£400 - £450 Per Day: Clearwater People Solutions Ltd: **URGENT CONTRACT ROLE**...

Market Risk & Control Manager

Up to £100k or £450p/d: Saxton Leigh: My client is a leading commodities tradi...

SQL Developer - Watford/NW London - £320 - £330 p/d - 6 months

£320 - £330 per day: Ashdown Group: The Ashdown Group have been engaged by a l...

Head of Audit

To £75,000 + Pension + Benefits + Bonus: Saxton Leigh: My client is looking f...

Day In a Page

Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits
Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam