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I’m Murdo MacLean. I am a client investment manager here at Walter Scott & Partners in Edinburgh.
I think valuation is a perennial focus for us. As long-term investors, it is true that high quality growing businesses can overcome short-term valuation pressures provided you’re willing and patient to see the qualities of those businesses come through. But it certainly always helps not to overpay for businesses, even with that long-term investment horizon. And being Scottish after all means that we’re pretty averse to paying more than perhaps what a business is worth.
I think entering this year the team had already identified the fact that, should we enter a period of rising interest rates, that would have a technical impact on discount rates that many investors pay attention to, particularly in businesses of long duration growth. We’ve certainly seen in the first quarter of this year, perhaps that’s slightly diminished in the second quarter, but at first quarter, a market shift away from your traditional high-quality growth businesses towards the cheaper end of the market driven by perhaps optimism around a global economic recovery.
And indeed the fact that those companies, in many cases, being more cyclical, perhaps less high quality, but also extremely cheap, that was a relatively easy trade for some investors to make. And I think that we felt that certainly from a performance standpoint in the first quarter.
And indeed we saw businesses like Intuitive Surgical, the robotic surgery business, that’s been a long-standing and great investment for the firm, we saw that come under pressure as it was an easy target for investors seeking to sell expensive companies, irrespective of quality, in favour of buying the cheaper end of the market.
We also saw some very key players, such as Taiwan Semiconductor, and ASML in the Netherlands, two really dominant semiconductor players in the supply chain high value add equipment, sold off also significantly. When to our eyes, the long-term outlook for those companies at worst is as good as it was before the pandemic, if not better in fact, going forward.
The tide, however, may be turning. I think central banks have been aggressive, very aggressive in some cases in their moves to quell inflationary pressure. And it seems they may be increasingly willing to take some economies into recession if that’s what it takes to get the inflation genie back in the bottle again. The risk now is perhaps around an earnings recession. That was the case three to six months ago. I think the upcoming reporting season in the United States particularly may well see a raft of earnings downgrades, having recently just been upgraded over hopes of an economic recovery.
Already we’ve seen the likes of Walmart earlier this week, kind of spook the market a little bit with its projections. However, I think we would look to the quality names in our portfolio to weather this storm more successfully. Microsoft and Alphabet both reported recently. And although they did note some slowing in growth and some of that growth was coming from a recovery from COVID, I think we were very encouraged as the market was also encouraged by the fact that underlying momentum was still remarkably healthy. I think on the medium to long term basis, we would certainly expect that to be the case given the growth areas in which they are operating.
So I think, should the economic slowdown persist, such resilience as we think appears in broad terms across portfolios that we manage, the more that that is prevalent against the backdrop of a weaker economy, the more the market may seek to reward, I think, such resilience.
Your question is around valuation. And yes, there’s been a degree of valuation compression, quite significant in a short space of time. I think with that now, to some extent, in the rear-view mirror there’s still a possibility of further contractions in valuation, but I don’t think of the magnitude that we have already seen.
Going forward, given the fact that the markets are off some 15, 20%, and some very high quality businesses in some cases are down more than that, now I think from a long-term investor’s perspective, your eyes turn to where are the opportunities because of that pullback. And it’s in periods like this that although Walter Scott might not engage in wholesale change in the portfolio, we may begin to start to cherry pick and be selective about some fantastic businesses that are now trading on much more attractive valuations than perhaps was the case just a few months ago.