Bruce Stout: Hunting for growth in a deflationary world

Bruce Stout explains why emerging markets may be a better bet for profits and dividends than traditional defensive stocks.

Watchthe full interview with Bruce Stout here.

I've interviewed Bruce Stout, the manager of the top-performing Murray International Trust, several times before.

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On each occasion, he's been pretty clear about how he sees the financial crisis unfolding. So I start by asking about something he has long warned is on the way deflation. Is this playing out the way he expected?

We aren't in outright deflation yet, says Stout. We'll only be there when "consumers start deferring purchases because they think they'll get goods and services cheaper in two weeks or a month's time". But the pressures are evident.

"A lot of customers have got debt" and there is "far too much capacity" chasing limited demand. That, says Stout, is a long-term trend. The jobs created in recent years have been low-paid ones: they don't contribute much to tax revenues and they don't sustain consumption. "For consumption-based economies, that's a real problem."

I point out that there seems to be a shift to higher wages, with raises for the most poorly paid at many firms in Americaand demand for a rise in the minimum wage in the UK. Stout isn't having this.There may be demand for higher wages, but except for jobs with scarce skill sets, wanting is different to getting.

In general, "real wages continue to fall in most of the developed world. That's what the numbers tell us and that's what the purchasing pattern tells us people continue to cut back on the volumes that they buy and they continue to trade down from branded goods into more generic goods".

Hmm. I say that Stout doesn't seem to be a believer in the great British recovery. He most certainly is not. "I haven't seen any evidence of any sustainable recovery that would match the type of stimulus that's been applied."

In the last six years governments and central banks have "really thrown the kitchen sink at the global economy" money printing has increased the size of some central bank balance sheets "by a factor of three or four times", yet the best we can generate is "2% or 2.5% growth that's very, very low relative to previous cycles".

It also puts us in an odd situation. "We've never seen negative nominal bond yields on €3trn worth of bonds in Europe. We've never seen being charged to put money in a bank in Switzerland, or Germany, or Sweden and Norway. We've never seen deflation; we've never seen prices fall and the pressure that puts on raising revenues."

Usually when you "try to use your experience to predict the future you look for evidence of things that you've seen in the past". But if you're facing a situation where many of those relationships are entirely new, "you have to be very cautious".

Focus on profits and dividends

Stout agrees that "on any historical measure markets are very, very expensive", due to the way in which central banks have "neglected their main job which is looking after growth and inflation in economies to focus on controlling asset prices".

This means that "you have to be very careful, because if you pay the wrong price" perhaps in a desperate search for yield "you'll lose your money". The only thing that holds an equity price up in the long term "is earnings and dividends". It isn't "hope and expectation" and itisn't "hot air and liquidity". So profitsand dividends are "absolutely key inthis type of low-growth, low-interest-rate environment".

So where is the best place to look for these? Not where most people think, says Stout. The traditional defensive areas are consumer staples and pharmaceuticals. But valuations here are high price/earnings ratios are in the 20s when the realistic growth rates are only in the single digits. Just because an industry is perceived to be safe doesn't necessarily mean that holding the companies within it is.

Instead, it makes sense to look in areas where there is "the definite tailwind of rising real incomes, of rising volumes and rising purchasing power". That means parts of Asia, Latin America and Africa.

These countries may be starting from a lower base than those in the West, but "they don't have the debt overhang"that we have. They have rising real incomes and demand for goods and services. Better still, they are "completely out of favour at the moment".

Right now everyone is convinced that the only good trades involve the strong dollar and the strong US. There's a level of conviction on this that we haven't seen since the 1998/1999 period, when America dominated returns. However, "we all knew what happened after that when the technology bubble burst". Better to be contrarian and look somewhere out of favour where good profits and dividends are realistic.

I agree (it's best to agree with Stout). But how does one invest in Africa? You can't really go direct, says Stout, because the markets are just too small, so you have to "look at companies in the developed world that are selling into Africa". South African mobile-communications firm MTM Group has businesses in Nigeria, South Africa and the Middle East, so could have "good growth ahead".

Investing in Asia isn't much easier, Stout adds. Markets there have grown in line with the economy, because there is a "great reluctance from families to go public with their companies". They have all the access to capital they need via the bond markets, so why would they want to float and suffer the scrutiny of analysts every quarter?

The result: "some of the best situations are still in private companies". Still, just as with Africa, you don't have to invest in companies with their headquarters in Asia to get exposure. Instead, you can look at companies such as Casino in France with large overseas exposure "that's still the main theme within the trust".

Don't pick favourites

I don't. But even if I did, I couldn't express it in the same way as a fund manager can express his feelings for stocks having more of one when it offers good value. Surely if a manager holds twice as much of one stock than another they must prefer the former? Not so.

"We don't have favourites," says Stout. But he does have huge respect for the people running the businesses he invests in right now. You have to "be very bold to spend money and invest for the future when the near-term outlook is very opaque".

I move on from favourites and ask about the most recent additions to the portfolio (same thing, right?). It turns out that only one new company has been added in the last year, Chilean potash and lithium producer SQM. The potash market has been tricky and there is "a lot of bad news discounted in the share price".

Stout intends to keep buying whenever there is weakness in the share price. So there you go. It might not be a favourite stock, but it is at least something Stout thinks is worth continuing to buy. Better than nothing.

Watchthe full interview with Bruce Stout here.