January's activity indicators remain upbeat, indicating a year of further corporate profitability in all major equity markets
The global growth momentum looks hard to derail
Global growth has been above trend since mid-2016 and, combined with high business confidence and low rates, is likely to support strong fixed asset investment in the year ahead.
Fourth-quarter GDP firmed to 3.4 per cent in the US, 2.9 per cent in the eurozone, 2.5 per cent in Japan, 6.3 per cent in China and 2 per cent in the UK. Activity indicators this month remain upbeat and indicate 2018 is likely to bring further support for corporate profitability in all major equity markets. The breadth of positive macroeconomic data points gives us confidence that, in the absence of adverse shocks, the momentum will be hard to derail.
As we enter the second year of synchronised strength, labour markets in the developed world are tight and unemployment rates are fast approaching their lowest level since the 1970s. Ten years on from the global financial crisis, sentiment readings indicate that households and businesses are slowly returning to more normal spending behaviour, which should promote higher wages as remaining slack in the economy is exhausted.
The acceleration in global goods demand and production has pushed capacity utilisation towards previous peaks. After three years of falling global business spending, the age of fixed assets stands above long-term historic average levels in many end markets. There is, therefore, a growing impetus for businesses to invest in new capacity and equipment.
Labour shortages and still-low rates of productivity add to the need to replace human capital with machinery. Meanwhile, corporates have de-geared to conservative levels in Europe and have the benefit of a one-off boost thanks to tax reform in the US, producing favourable financial conditions for investment.
Financial conditions have arguably been easy for a while, with a low cost of debt relative to history giving companies greater optionality to invest in higher risk or lower-returning projects. Corporates have, until recently, chosen to de-lever or route spare capital towards share buybacks, which indicates confidence in end markets is a bigger driver in capital allocation than capital abundance.
With global corporate profits and business confidence likely to remain high, this virtuous circle underlies our belief that global capex spending is back. Last year marked the first year of capex growth since 2013, with global business spending tracking a 7 per cent annual increase; we expect gains to persist this year.
From an investment perspective, the stock market will not reward capex growers indiscriminately. Investors must disaggregate business spending to identify sectors and businesses spending defensively, for example, to fight against disruptive competition or higher regulatory costs, and those that deploy capital accretively to tap into incremental top-line opportunity.
Another group that is well positioned for a sustained capex cycle is value chain beneficiaries. Regardless of the type of capex (ie defensive or growth-oriented), such businesses could prosper from others spending.
When picking stocks that can benefit from a revival in global capex, we see opportunities across most end markets but have a particular preference for industrials. Industrial companies have rerated relative to the market, but a premium valuation can be supported by superior top line delivery. In addition to a favourable revenue outlook, we seek out businesses that have other drivers to supplement profit delivery, for example, restructuring.
Finally, investors must not overlook the longer-term structural shifts taking place in the way corporates spend. Within capex, a bias towards automation and intangible investment has been building for some years – with software spending taking a larger share of the wallet at the expense of physical equipment. Technology companies are, unsurprisingly, positioned to benefit from further secular disruption across a wide range of end markets, while semiconductor businesses can also capture the cyclical upswing.
Grace Peters is the global equities strategist at JP Morgan Private Bank