‘Air pockets’ the risk as earnings season extends

If you only looked at the share prices of global equity managers GQG Partners (ASX:GQG) and Magellan Financial Group (ASX:MFG), you would be forgiven for thinking they were groups heading in very different directions. Yet the annual updates delivered by their high-profile chief investment officers, respectively Rajiv Jain and Hamish Douglass, highlighted a few similarities.

It sounds like a meteorological or aviation term, but “air pockets” is how both managers described perceived mispricing in some of the world’s highest-quality growth companies. In both cases, they were referring to the fact that many companies, including the world’s largest in Apple Inc. (NYSE:AAPL), are being priced on a “best-case scenario” basis.

For instance, Jain highlights Apple’s revenue growth forecasts in 2019, which were around the mid-single digit level, but which actually came in at about 30 per cent in 2020 and 2021. Personal computer sales, for instance, grew at a 30 per cent clip, being close to 40 per cent higher than their normal “run-rate” of sales. While GQG isn’t taking a view on whether this 30 to 40 per cent is sustainable, Jain raises the point that if earnings season shows growth anywhere below this, the share price will likely be punished.

Turning to Douglass, and he suggests that “the bubble hasn’t yet burst” when it comes to non-profitable technology companies. The 30 per cent correction experienced thus far is “hardly a crash,” and “dip buyers” might be surprised by the depth of the falls. He flagged the trillions of dollars invested in this sector, comparing it to cryptocurrencies’ rise, both of which Magellan consider “crowded trades.”

But it wasn’t all about overvalued tech: both groups were in agreement once again when it came to a number of “overcrowded” backward-looking quality trades. In Magellan’s case, it was referring to companies benefiting from the economic recovery, which are now priced like growth stocks; while GQG warned of the “pull-forward of earnings” triggered by the pandemic and the limited certainty anyone can have in earnings at this point.

“We have lived a lifetime in the last two years,” said Jain, as he flagged the need to take a step back and consider valuations on a longer-term basis. Broadly speaking, he says, “valuations are on the high side,” with any company showing consistency of earnings having been priced-up aggressively. Yet he is concerned that “the world hasn’t changed as much as we believe,” and the risk of mean-reversion for many of these companies is extremely real.

One example he highlighted was the fact that liquor companies around the world are trading at substantial premiums to beer companies, as the former benefit from people staying at home.

With close to one-third of the S&P500 population down more than 50 per cent, but the market trading near all-time highs, GQG is seeking diversification outside the big names and major sectors. It remains wary of Chinese regulation along with the semiconductor play, moving significantly overweight to energy and materials companies in the most recent quarter.

Douglass, on the other hand, has turned to the unloved travel sector, adding two holdings that are direct plays on a recovery in travel volumes, or bums on seats. These are French company Safran (EPA: SAF), which supplies engines for the most in-demand narrow-bodied aircraft, and Spanish travel IT business Amadeus (BME: AMS), which manages the ticketing and boarding process across airports, flights and hotels.

Ultimately, the view from both global investment leaders is one of conservatism amid an environment of growing uncertainty.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.