A more differentiated approach is desirable

For Thomas Meier, manager of MainFirst, much of the negative news is already priced in.

After a steady decline until mid-June, equity markets rebounded sharply throughout July. What should we think of this recovery and what aspects should we pay special attention to for the rest of the second half of the year? Update with Thomas Meier, a portfolio manager specializing in European equities and equities offering attractive dividends on MainFirst.

In July, as in early August, there was a strong recovery in the stock markets. How do you analyze this evolution?

Equity markets have rallied in recent weeks as market participants believe inflation will only peak in the coming months. There is also a sharp slowdown in the prices of many raw materials. Combined with the slowing economic momentum, market participants expect weaker inflationary impulses, which should prompt central banks to act more deliberately on monetary tightening. Added to this is the current activity report publishing season. Companies are certainly reporting the repercussions of the economic downturn, but fundamentally, there is no significant decline.

“We are seeing a robust earnings season on both sides of the Atlantic.”

What conclusions do you draw so far from the earnings season for the numbers published at the end of June in general?

We are seeing a robust earnings season on both sides of the Atlantic. In the United States, two-thirds of companies exceeded their sales forecasts and three-quarters of their profit forecasts. In Europe, three-quarters of companies beat their sales forecasts, but only half their profit forecasts. European companies appear to be passing on their rising costs to end customers, but not to the extent necessary to maintain margins. This is mainly due to the high energy costs resulting from the war in Ukraine.

What aspects should you pay special attention to when analyzing or selecting companies in the current context?

Having pricing power and the ability of a company to pass on any increase in input costs to its customers is certainly one of the most important criteria to consider in the current environment characterized by high inflation. In addition to this aspect, we must also carefully observe whether there have been variations in demand for a company’s products or services or if we have observed changes in the behavior of its customers. Finally, we must also look at the extent to which a company is flexible enough to adapt its cost base.

Overall, however, I have the impression that the “cocktail” of very negative news that followed one another during the first half of the year had a strong influence on investors’ perceptions. From my point of view, there is a lot of negative news that is already priced in.

Going back to some of the things you mentioned, why is the ability of companies to dictate their prices so important now? This is not an important criterion at all times…

It is yes. However, I have never experienced a phase comparable to the one we are currently experiencing. Several factors combine: companies face a severe shortage of labor and have to pay the higher wages demanded by staff due to rampant inflation in many countries. And this comes at a time when the economy as a whole is not overheating, which is a difference from other periods leading up to stock market corrections. For example, in 2021 there was no overheating phase of the economy comparable to that of the housing market before the 2007 global financial crisis or that preceded the dot-com bubble at the beginning of the millennium. I don’t see such excesses now. Of course, there are significant problems like inflation and interruptions in production lines. On the other hand, many companies still have healthy balance sheets, their profit margins are still high. They are generally “fit” in general and are capable of facing crises.

“In 2021, markets were clearly too euphoric. In 2022, they turned to widespread pessimism.”

That speaks in favor of the continuation of the rebound…

We cannot ignore the many uncertainties that persist, especially with regard to energy supply in Europe. Energy will remain a scarce commodity in the coming months and companies would do well to diversify their energy sources as much as possible. Despite everything, the markets have already priced in much of these uncertainties. As Warren Buffett said, “Mister Market” can be temperamental. In 2021, markets were clearly too euphoric. In 2022, they turned to widespread pessimism. I think a more differentiated approach would be desirable.

In a note to investors, you just spoke of an undifferentiated liquidation that now allows investors to now buy “highly competitive” companies at an attractive price. Which company profiles are you thinking about?

Markets no longer really differentiate between companies of very different quality. In Germany, France and Italy alike, you find many companies that have emerged stronger from the COVID crisis – the most competitive companies in their sector have often become even stronger, the nimblest among them are even quicker to react. – and yet many of them companies lost 20, 30, 40% of their value between January and June, or even more.

Are there examples of companies in Switzerland too?

Yes, there are many. There are a large number of SMEs in Switzerland that are excellently positioned in a certain niche area and that are able to show resilience in an inflationary environment. Several top-class Swiss companies corrected enormously in the first half of the year. If we take the example of a mid-cap that recently released its semi-annual results like Interroll, the performance of this specialist in logistics equipment is a typical example of this type of trajectory. In November 2021, the Interroll title was worth over 4,800 francs, then halved to approach 2,000 francs in mid-June, before bouncing back a bit in July. I wouldn’t venture to make a price prediction for this company’s stock, but I think the correct stock value should be somewhere between these two extremes. This is an example that shows how “Mister Market” can experience spectacular mood swings within a few months, without these swings being justified by a fundamental shift in a company’s valuation.

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