“The incremental outlook for the central bank `cavalry’ riding to the rescue is negative,” McConnaughey said. “The question for the US Fed is not if, but when they will raise rates and uncertainties have increased regarding incremental policy actions in Japan, Europe and China filling that potential void.
“Further, this does not answer the question of whether further easing would actually fundamentally help if it did occur. Many strategists and economists rely on models based on the premise that lower rates/incremental liquidity always eventually leads to a growth response.”
The lack of cheap credit is not the remedy for a sluggish economy. The real problem, he said is “massive amounts of global production capacity seeing returns eroded by forces of globalization and technological change” as demand from China falls.
Capital-intensive exporting companies are taking a hit and central bank action is not a remedy because it keeps inefficient businesses alive, he said.
Zombie capacity
“Perhaps the situation rhymes with the Japanese experience of the last 20 years, where very low interest rates did little to fix a massive misallocation of capital, even probably delaying steps toward a real healing process by keeping `zombie’ capacity in place.
For investors, a company’s competitive position is emerging as a critical area. Stock pickers who do their homework will find opportunities, McConnaughey said.
He sees “an environment where neither overall global growth or central bank policy will rescue uneconomic, inefficient production capacity. There will eventually be a necessary wave of closures of uncompetitive businesses,” McConnaughey noted.
“It will be increasingly important to ensure that any investment we make is made with an intense focus on fundamental competitiveness. We do see interesting values emerging from this selloff, but avoiding `value traps’ will be crucial.”
Contrarian on energy
Stock-picking opportunities will emerge for truly innovative businesses, such as those in software creation and biotech engineering – where the long-term story has not changed but valuations are becoming more forgiving, he believes. Investors should turn their attention to the US, which has a disproportionate share of such businesses.
The energy sector, where economics are driven more by throughput volume than commodity price, also presents interesting opportunities. McConnaughey noted that the sector was hit badly and many large-scale companies were disproportionately punished.
“We begin to see security selection opportunities where babies are thrown out with the bathwater.”
He also believes investment-grade fixed income is a viable option for investors. “Worth noting is the pain in examples of investment-grade fixed income, where some examples of mergers and acquisitions or activist activity straining balance sheets has caused a `shoot first, ask questions later’ widening of spreads across the sector,” he said.
