Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about valuations and opportunities with James Sutton, portfolio manager with J.P. Morgan Asset Management’s International Equity Group. We talked about regions, sectors and names he likes; and we started by asking about the current market.

James Sutton (JS): I don’t want to sound complacent about potential recession risk. We’re forecasting a 10% decline in earnings in Europe, 4% decline in earnings in Japan this year. So, we’re trying to factor in some slowdown in our forecasts. Many market participants are conditioned into thinking that a recession is some kind of apocalyptic event associated with a large market drawdown. But you can have mild recessions where some of the excesses of previous cycles are worked through in an orderly fashion. And a mild recession is our base case. And, actually, what we’re finding is, having taken a knife to numbers last year, in anticipation of a recession, we’re finding that we’re having to nudge those numbers back up. We’ve been quite struck by the number of companies that are positively pre-announcing because they’re going to materially exceed previous guidance. And what we’re hearing from companies at the moment is that operating conditions are still very robust.

Pockets of opportunity

JS: One area where our research process would point us would be banks, and European banks in particular. Now that sounds counterintuitive in the context of a potential recession and fears of contagion from the U.S. regional banking crisis. But we think European banks have been properly regulated. And we also think that the market is pricing in a rapid normalization of net-interest margins for the banks. Banks should be able to make more money next cycle than the previous cycle, and evaluations don’t reflect that. Another area would be semiconductors. There’s a classic inventory correction going on at the moment. But that is providing a good entry point for long-term investors. The long-term fundamentals of this industry remain incredibly attractive, whether it’s generative AI leading to enormous memory demand, or greater semiconductor content within autos and industrial end-uses. And within international markets, we can find some really exceptional companies that dominate the industry. So, TSMC [Taiwan Semiconductor Manufacturing Company Limited, based in Hsinchu, Taiwan] in leading-edge foundry. Samsung as the low-cost memory producer. ASML [ASML Holding, based in Veldhoven, Netherlands] which has a monopoly on leading-edge lithography equipment to make semiconductors. These are the very dominant companies within the semiconductor sector, and will be big beneficiaries of growth in that industry, and they’re not trading on expensive valuations today.

The power of branding

JS: Another area or group of companies that we find attractive is the luxury-goods companies and beauty companies. So, Louis Vuitton [Louis Vuitton Malletier, based in Paris, France] and L’Oreal [L’Oréal S.A., based in Clichy, France] would be two names that would stick out there. And, in terms of their competitive advantage, it’s really brand, and their ability to make a huge markup on their costs because of that brand cache, and that heritage that is associated with those brands. But you can see it in other sectors as well. Having a brand is very important within banks. Having a brand of being, you know, conservatively run is key to building an effective deposit franchise in emerging markets, and that would be for companies like HDFC Bank in India [HDFC Bank Limited, based in Mumbai, India] or Bank of Central Asia in Indonesia [PT Bank Central Asia Tbk, based in Jakarta, Indonesia].

And finally, what’s the bottom line on global equity valuations?

JS: I’d say that global equity valuations, in aggregate, were reasonable. But there is still a big opportunity in global-ex-U.S., versus just the U.S. If we think about where earnings leadership is going to come from over the next cycle, it isn’t necessarily all about U.S. tech. You often see earnings leadership shift, cycle by cycle. And we would expect the next cycle to be less about intangible investment technology, and more about tangible investment as we invest behind the energy transition, as we invest behind supply chains trying to make them more resilient. And so that means sectors like industrials, materials, energy are likely to be where we might see earnings leadership, as opposed to U.S. technology, which was really the sole sector which drove U.S. earnings outperformance over the previous cycle.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to James Sutton of J.P. Morgan Asset Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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