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SIMON BROWN: I’m chatting with Sean Ashton, head of investments at Private Clients by Old Mutual. Sean, appreciate the early morning time.
A great piece you wrote recently. You talk around all the screaming headlines that we see out there pretty much across the board. They are scary headlines. Broadly though, markets are moving higher.
You make the case that they really are being driven by strong earnings, regardless of what the headlines are saying. You say you’ve seen some of the best earnings potentially in your investment career.
SEAN ASHTON: Good morning, Simon, and good morning to your listeners. Yes, it’s a lot that you’ve unpacked there and you’ve summarised it very well, quite quickly. But I think the long and the short of it is that we’re in an investment boom – certainly in the US – that I haven’t witnessed in my career. It’s obviously centred on AI. Many listeners will be aware of that.
But what’s quite notable is that when we look at the aggregate earnings growth of the S&P 500, expectations for this year are about 26% year-on-year growth.
And, if you look back over the last 25 years or so, pretty much from the turn of the millennium to now, what’s notable about that is that it’s occurring in the context of not being recovery or for a recessionary period.
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So when we look at historical periods of very strong earnings growth comparable to that number or better, it has always come off the back of a recessionary recovery.
In this case we’ve had two years of pretty decent growth – even prior to this. So it stands out in the sense that it is the strongest in the last 25 years that has not occurred coming off a recession. And that’s notable.
So this is genuine investment-led very strong earnings growth that we think could continue for a while.
SIMON BROWN: Yes, it is, and that’s a big number. I mean 26% is a big, big number, make no mistake about that. But it does what it means. And what I’ve seen in some of the stocks I’ve been having a look at is that stocks have been running, but with that sort of earnings behind them. And to be clear, that’s the average. So we have a bunch doing better than that.
On valuations – and there are many ways to value, I appreciate that – broadly we can say valuations aren’t as scary as some of the elevated prices would lead us to suggest.
SEAN ASHTON: This is what’s notable, Simon. Look, it has been a very narrow, narrow market in terms of leadership. It has basically been semiconductors and not much else. So your picks and shovels of the AI boom have been the ones to be the first-order beneficiaries. That’s obvious.
We’re actually looking for the next leaders. It’s not clear what those are yet; we’re doing a lot of work on that. But certainly if you look at the semiconductor space you’ve had many stocks that have gone up hundreds of percents.
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Curiously their PE multiples in cases have actually come off over the last 12 months or so – and that tells you the extent of earnings upgrades that we’ve seen in this space.
Even if you look at the S&P 500 in aggregate, PE multiples are well off their highs. I think we’re trading somewhere around 20 or 21 times next 12-month earnings.
I hear this term ‘AI bubble’ bandied around a lot. It’s certainly not showing up in the valuation multiples. The questions that we would ask ourselves longer term is how long the earnings cycle lasts – or are the margins sustainable? Is the capex cycle sustainable? Those are the better questions to be asking.
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SIMON BROWN: That’s a great point because there are always risks. The assumption that just because markets have gone up makes them too expensive is not necessarily the point.
But there is an argument to be said, kind of get those, I don’t know, ‘tripwires’ for a phrase, that we can keep an eye on if margins start to shrink, if capex suddenly collapses – whatever it might be. That could be that warning signal.
SEAN ASHTON: Absolutely. And I think the big kind of hairy question we’re asking ourselves at the moment – and you’ve seen it in the valuations of the so-called hyperscalers, companies like Microsoft, Meta, Amazon, Alphabet, et cetera, and Oracle is probably a more recent one you can throw in the mix – [is about] these companies that have transitioned from very capital-light platform businesses into extremely capital-intensive infrastructure businesses.
Now it looks to us like the returns on capital are good. But the point is that there’s a lot of capital being deployed.
We think that group of companies will spend something of the order of what will certainly be call it $750 billion on capital investment this year, and I’m sure more north of a trillion next year.
These are crazy numbers. We’re talking dollars here.
The question to us is do the returns on capital remain competitive in the after years as the base continues to get bigger and bigger?
And ultimately what does that mean for the ratings of these companies because they’re very different beasts from what they were a few years ago when they were buying back stock and just managing their capital bases down? Now they’re doing the opposite.
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SIMON BROWN: A great point. It has fundamentally changed.
A last question. To go back to your point, you talked around the next leaders. I sometimes lie awake at night stressing that I’m not finding them. The flip side is you said you’re still looking for them. We don’t need them. We don’t need to know what they are today.
We can find them in time. We can change our minds about it. What I’m trying to say is there’s some flexibility in who it’s going to be and how we are going to respond.
SEAN ASHTON: Absolutely. I’m so glad you mentioned that, because it’s all about flexibility – and often the market tells you where to look. And certainly it’s not obvious outside of semis [semiconductor stocks] right now, but I think what will start to show up is relative strength.
Stocks start to outperform consistently in a new sector or subsector, so the leaders will show their hand. I think that’s the key and we’ve got to be on the lookout for them.
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SIMON BROWN: I like that. The leaders will show their hand. They will. We just need to make sure that we are looking, because we will see it when it comes.
We’ll leave it there. Sean Ashton, head of investments, Private Clients for Old Mutual, appreciate the early morning time.
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