Tim Richardson CFA, Investment Specialist
The impact of the global economic slowdown on profitability will be highly stock specific. Earnings will depend on company sensitivity to interest rates, consumer spending, and secular growth trends. This will bring share market investors a wider dispersion of returns.
“So I think the winners in recessions are the people who produce new technology that does things better, which people really want.” – Sir James Dyson, Inventor and entrepreneur
Our previous article reviewed the factors which drove weaker share markets in 2022, despite earnings holding up reasonably well. We then considered the factors that could slow overall market earnings, risking some lower share prices in 2023. We will now examine the business models which are best positioned to grow earnings in a slowing economic environment.
Can equities really do well during a slowdown?
The short answer is yes. Some companies are likely to grow their earnings and see stronger share prices despite the slowing global economy. Of course, the difficult bit is trying to identify such companies in advance.
Such companies often have two things in common:
- Lower sensitivity to interest rates, which are expected to remain elevated
- Lower sensitivity to consumer spending, which is expected to remain subdued
More fundamentally, it is a business model’s exposure to longer-term structural growth trends that enables a company to grow earnings throughout the business cycle.
Which companies can grow earnings as the economy slows?
Despite the current slowdown, ten long-term structural shifts in the global economy provide opportunities for certain companies to grow earnings.
- The switch to net zero will benefit not just manufacturers of electric vehicles and solar panels but a wider range of critical components such as lithium batteries and high voltage cables
- Labour shortages will drive vehicle automation, supporting innovation not just in cars, but also in semi-trucks, agricultural vehicles, ride sharing services, and semiconductors
- Aging populations in developed economies and Asia will support spending on health care, including medical insurance, care facilities, and pharmaceutical development
- Changing retail habits are positive for companies providing unique home delivery services or supporting infrastructure
- Global travel reopening is boosting demand not just for airlines and hotels but also payment services and luxury goods which are highly sensitive to leisure and business travel
- Delayed family formation brings a larger cohort willing to spend a premium on high quality goods and services, which can secure higher margins
- The rise of the middle class across China and other emerging markets continues to drive earnings, not just of local companies in sectors such as technology and healthcare, but also western brands
- The Great Dislocation – as trade between the US and China separates – provides opportunities for key component makers (e.g. semiconductors and electric vehicle batteries) well aligned to changes in government policy, i.e. onshoring
- Reshoring to higher cost territories increases demand for factory automation to manage the impact of more expensive labour
- Trust in strong brands mitigates the impact of falling discretionary spending on earnings growth in sectors as diverse as leisure wear, cosmetics, and confectionary
So what does this mean for investors?
We are now seeing lower corporate earnings, driven by falling real household incomes, higher mortgage payments, a slower housing market and rising corporate financing costs.
This is bringing share price volatility and may well prevent a near-term rebound in the overall equity market. In this environment, many cyclical stocks whose revenues are sensitive to consumer spending are expected to underperform as they struggle to grow earnings.
However, companies whose business models are well aligned to secular growth trends which will endure throughout the interest rate and consumer spending cycles are better placed.
Investors should now consider selectively establishing some exposure to quality global growth stocks, following the market turbulence of 2022 that leaves many at highly attractive valuations.