The head of North American equities at a $400 billion investor talks stocks and the year ahead

Aberdeen Asset Management

Business Insider caught up with Ralph Bassett, the Head of North American Equities at Aberdeen Asset Management, to help make sense of the current state of the market and the outlook for the year ahead. Bassett is a 10 year veteran of the firm, which has $402.9 billion under management. 

Bassett discussed the exogenous shocks that have shaped the US markets over the past five years, the trend towards passive investing and the importance of consistency in an uncertain political and economic time. 

This interview has been edited for length and clarity. 

Tina Wadhwa: How can investors protect themselves in the midst of political uncertainty? 

Ralph Bassett: From our standpoint and investment philosophy, we’re invested in companies that don’t necessarily benefit from one theme that’s going to be dominated by either candidate's changes to policy.

There’s obviously some things in the market that are likely to be more pronounced regardless of who gets into office. Where we’ve been focused on in terms of the impact to companies is certainly healthcare. Regardless of who comes into office, there’s certainly a view that a slowdown in price increases, if not outright price declines, will be witnessed across the pharma landscape, especially in areas that are more commoditized or where there are competing drugs. There was news that the DOJ is now investigating a lot of generic drug companies. And certainly the fact that the government can’t agree on price directly with the drug manufacturers is something that will come into the fold over the next few years.  

The second area is infrastructure spending. Whether it’s a wall to Mexico or bridges and roads, there will be certainly be more spending on that front.

And thirdly, we do think that there’s a lot of cash overseas and that both candidates are of the view that whether it’s a tax holiday or wholesale change in tax policy, one of the issues that a lot of businesses have is how do you appropriately bring cash back to the US. And that’s been ongoing for the past decade.

Wadhwa: Aside from the election, what’s the biggest risk to markets in 2017?

Bassett: I think the world is a bit distorted in the sense that you have Japan, Europe, basically every developed market ex the US having very relaxed, and increasingly in some cases, accommodative monetary policy.  I think the impact of interest rates and what that means for the dollar is a concern. Obviously looking at the bottom up from the company standpoint, one of the things we are very concerned about is the increasing leverage across US corporates. Leverage has gone from, if you’re looking at smaller companies, roughly 1x up to 2x, and that’s really been driven by low interest rates.

But I would also argue that low GDP growth has enticed companies to focus on acquisitions rather than organic investment in their business. 

Wadhwa: What's your outlook for Fed rate hikes through 2017? How is the equities market going to respond?

Bassett: I think the market is now digesting rates quite well. There’s still the question mark over the pace of further rate hikes beyond December, January or whenever we actually get there. 

From where we stand, it’s a question of what it means for the equities markets in terms of valuation. We’ve been scratching our heads for awhile over some of the valuations we’ve seen in real estate, in terms of REITS, and in terms of utilities as well. There’s a big portion of the market that’s been bid up certainly due to the view that interest rates are going to be accommodative for quite some time, which may be the case, but then also there’s a thirst for yield against specifically fixed income markets. So we’ve seen all the yielding sectors have a strong underpinning going back to 2012 in this case. So in our view is that eventually that will unwind.

Coming back to my earlier point about wanting to find businesses that are less distorted,  tech is one area where you can find businesses that are agnostic to the level of GDP growth.  They have innovative business models that are in demand and often times  help companies save money. We’ve seen a shift as well of companies being in cost savings mode to now an acute focus on how do we become offensive, how do we drive revenue, and technology, whether it’s better CRM or better architecture, all helps in that aspect. So, our view is that valuations on a company by company basis can be difficult to get your arms around. But there’s a lot of companies that are priced to be acquired and we always have to be careful to make sure that’s not in our thesis. 

Wadhwa: It seems that the stock market has either been doing nothing or going wild in 2016. What has been driving this and will it continue?

Bassett:  If you think about it, a lot of what’s happened to the US market has really been exogenous in nature. In 2012 we had issues around Grexit and the wider Euro crisis, more recently we had the weakening of the Chinese currency,  and earlier in Jan, there were concerns about the global macro environment.

I think certainly going forward, we’re of the view that absent economic acceleration, which we don’t necessarily forecast, multiple expansion in the market is going to become more difficult. That’s what we had seen propel markets from the recession up until 2013 and 2014. And now there’s much more sensitivity on the underlying growth in companies, so that’s why you’ve seen markets become more jittery, aside from all of the macro noise that’s been playing out.

Wadhwa: We're seeing a trend towards passive investing.  What's your perception of this trend - in terms of its magnitude, and the reasons behind it.  How do you see it affecting your business?

Bassett: The reasons behind it are a couple fold. The biggest reason is fees. There’s a lot of pressure, whether it’s from 401k fiduciaries or new DOL regulations that are pushing people towards lower fee products at a high level.

I also think that the market has, at least for large cap managers, been more difficult the last few years where there’s been several index weights that have dominated returns. That said, the more markets go passive, the better it becomes for active managers. So it can be painful in the short-term, but longer term there will be a very good place for active managers. Our process is well suited to that. We’re concentrated, we’re focused on good businesses. Driving alpha through stock selection is what we will continue to do over time.

Wadhwa: Business in the US has profited extensively from globalization.  Given the political debate on both sides of the US political spectrum is turning more introspective - with more aversion towards free trade and free movement of labor - is this going to weigh on equity returns in the medium term?  Is the globalization return premium going to decrease, or turn negative?

Bassett: I think it depends on which candidate comes into the office. There’s this broad view that markets are becoming more isolationist. Brexit is the first point that people are looking at. I think broadly a lot of the companies that we look at are looking to emerging markets for growth. You’re in a market where GDP growth on a good day is maybe 3% and then you can go invest in a lot of emerging markets and get GDP that’s double that and also new markets where there may not be as many, if not any, competitors. 

Wadhwa: What's something that markets aren't paying enough attention to?

Bassett: How are companies delivering earnings. From a US context in particular, the market is obsessed with EPS growth and we as managers dissect how that’s delivered. Margin improvement can be a very good thing but is a company investing enough? Secondly, acquisitions can help deliver EPS growth, but that’s led to the market seeing an upward trajectory in leverage, which is not the healthiest way to deliver EPS Growth.

Wadhwa: What's the biggest thing on your clients' minds right now that they keep asking you about?

Bassett: I think the biggest question mark people have had is really the valuation of the US market. Especially in a relative context to say Europe, where valuations are lower and monetary policy is still accommodative. That’s the big question mark. What’s the impact of rates against a market that’s done very well on a global basis, and valuation may be reflective of that.

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