The search for the most attractive investments usually leads to high-quality businesses, with wide margins, high returns on equity, strong balance sheets and attractive valuations. The four broad investment styles — value, quality, growth and income – are all based on some variation of the above factors.
One set of companies that is generally avoided by most investors are the least efficient, low-margin companies with business models that rely on government subsidies or other public sector initiatives.
However, a new research presentation by Macquarie puts forward the idea that these businesses could become the most attractive investments as central banks reach the limits of conventional monetary policy and fiscal policy is employed to stimulate economic growth.
Analysts at Macquarie believe that the next logical step for central banks is to change policy settings from pure monetary QE towards QE that involves direct financing of fiscal spending, income support and infrastructure investment. If adopted this strategy could lead to big changes in how portfolio managers select stocks. ‘Follow the government’ and ‘buy the least efficient and most protected’ local stocks could emerge as key portfolio manager strategies as a result.
Macquarie isn’t the only firm that’s touting a stock strategy designed to take advantage of fiscal stimulus as monetary policy reaches it limits.
At the end of June, equity analysts at JP Morgan wrote in a research note to clients that with interest rates approaching or breaching the 0% level, monetary policy is at risk of becoming increasingly less effective.
The analysts went on to highlight that US public fixed investment as a share of GDP is running near 60-year lows and at some point in the future, whether policymakers like it or not, the US government will be forced to spend on public infrastructure programs to make up for decades of underinvestment. That said, the analysts went on to note that it’s unlikely this will take place in the near-term. Governments in Europe and the US still seem to be far away from adopting such a policy.
Still, the calls for a fiscal policy response to sluggish economic growth are getting louder by the day and Japan has already caved to calls for a massive fiscal stimulus. Just two days after JP Morgan’s note was published Japan’s prime minister unveiled a surprisingly large ¥28 trillion ($265 billion) stimulus package.
Buy weak balance sheets?
There may also be a case here to buy low-quality stocks with weak balance sheets. Research published by Bank of America last week showed that during July low-quality equities, (S&P quality ratings of B or worse) beat high-quality stocks (B+ or higher) by 2.3% in July after trailing by 5% in the first half. Further, the lowest quality stocks (S&P quality ratings of C and D) gained an average of 10.6%, their strongest month since January 2012. Clearly, low-quality stocks have caught a bid thanks to the increasingly dovish tone from central banks. If monetary policy remains accommodative, this trend could last for the foreseeable future.