It’s been a very positive start to 2019 for stock markets on both sides of the pond. There has been a fairly relentless rise since the Christmas Eve low. It’s starting to feel like the worst of the correction may be behind us. However, in the short term we seem to be near a point of inflection, with the US indices bouncing around near the 200 day moving averages and the FTSE not far behind. As ever, it could go either way from here. Either way, I’m feeling vindicated in my decision to remain fully invested through the recent volatility. I might have gained in the short term from selling out but it would have been bloody hard to decide when to get back in.
The Federal Reserve, the apparent source of a lot of the woe we experienced at the end of last year, has relented on its hawkish tone. It has tempered its view on the strength of the US economy and signaled more doveish policy for the coming year. It is somewhat perverse that the stock market seems to view the Fed’s more pessimistic economic outlook as a positive. Apparently, the market agrees with this more pessimistic outlook and cares more that the risk of a monetary policy mistake incorrectly based on an over-optimistic outlook has now been reduced. I suppose this makes sense but the logic feels rather precariously balanced.
Overall, the macro situation doesn’t seem too bad to me. Economic growth is slowing down globally, as it inevitably does from time to time, but it’s not clear that this is going to lead to a significant recession (yet). While Brexit and the trade war between US and China create some short-term uncertainty, I don’t see them as major concerns. Slowing Chinese growth is more troubling as a long term issue but it may well stabilise.
Well that’s my take. I don’t have much confidence in it and I don’t need to – trying to second-guess where sentiment about the economy may drive the stock market next is fascinating but not one of the better ways to play the investing game. In my view it’s better to remain fully invested unless there is very good reason not to.
On the individual company front, earnings season has been a bit of a mixed bag so far. It’s generally been fairly positive for the stocks in my portfolio with no major upsets, though ex-holding Accesso Technlogies had a rather unsettlingly vague profit warning. Its quality has certainly come into question and I’ve axed it from the watchlist as a result.
One bright spot has been enterprise IT, where many of the companies on my watchlist (and some not on it) have been serving up some great earnings-beating results. No sign of any slowdown in growth here. As I wrote in this post, it seems pretty clear that enterprise IT is a sector with attractive economics, favourable competitive dynamics and huge growth potential. I imagine it is likely to host the next wave of tech giants.
For last week’s trade I bought Stryker. I sold my position in Keywords Studios for a small loss, fortuitously before it crashed a lot further along with the rest of the video games sector last week.
Stryker is a US medical technology and equipment supplier, selling things like surgical implants and equipment. It is a very large company, valued at around £50bn, and is a holding of Terry Smith’s Fundsmith. It has an aquisitive ‘buy and build’ strategy. It is more of a solid defensive pick rather than an exciting growth opportunity.
- Business economics: the economics look decent. Stryker is consistently profitable with decent margins. Its returns on capital are in the low teens, which is reasonable but not great. It has historically had fairly low levels of capital expenditure, though these have increased somewhat in the last couple of years. It has also been spending quite a bit on acquisitions.
- Track record: Stryker has a long and illustrious track record. It has been steadily growing since its creation in the 1940s. Over the last decade it has experienced very consistent growth in revenues and profits. You can’t discern any impact of the Financial Crisis on its financial accounts, illustrating its defensiveness. Based on the consistency of its track record, it looks to be very high quality indeed.
- Competitive advantage: in common with other medical device suppliers, Stryker’s main source of competitive advantage comes from the nature of its healthcare customers. These customers tend to care more about quality than price and are ‘sticky’, in the sense that they are often reluctant to switch to alternative less proven products solely because they are cheaper. The competition Stryker faces is more dynamic i.e. from competitors innovating to create technologically superior products. Stryker is likely to have some advantages from its scale and expertise in technological development. It has had to continually innovate throughout its history. Its distribution network is also a major advantage – customer relationships and relationships with medical professionals are critical to ensure innovations are adopted. Finally, its wide and diversified portfolio of products means the threat it faces from any individual competitor innovation is limited.
- Growth prospects: the long term growth prospects are excellent. While Stryker’s large size means explosive growth is highly unlikely, healthcare markets are defensive and benefit from strong secular growth drivers. On the downside, there is political pressure to reduce healthcare costs in the US, where Stryker does most of its business and around the rest of world too. This means that Stryker may occasionally face increased price regulation or taxes. For example, the Affordable Care Act imposed a excise tax on medical devices that has yet to come into force but may do at some point soon. I don’t see this as a significant cause for concern over the long term.
Momentum is excellent with Stryker recently releasing a very strong trading update and the share price breaking out to new highs. The valuation seems very decent given the relatively high degree of certainty in long term growth prospects.