Macro indicators indicating a slowdown in Europe and UK
We pay good attention to the macro environment and recent indicators point to a slightly alarming (although not unexpected) slowdown in the European and UK macro environment.  Since inception of the Clime International fund we had less exposure to both Europe and the UK to what an index based investor would have had and these economic numbers confirm our suspicion that investors have to be careful of the wider European investment environment.
It appears that Britain’s decision to exit the EU (‘Brexit’) is having a negative impact on its economy, as the U.K. Composite PMI dropped -4.7 points to 47.7 (a 87-month low).  The U.K. Services PMI fell -4.9 points to 47.4 (88-month low) and the U.K. Manufacturing PMI fell -3.0 points to 49.1, both indicating contraction.
The Eurozone PMI Composite Index fell -0.2 points to 52.9 in July.  This is the lowest level since January 2015 and suggests slower growth in the EU.  Nonetheless, despite the slight slowdown, this is the 37th consecutive month of growth in the EU.  The Manufacturing PMI declined -0.9 points to 51.9 and the Services PMI declined -0.1 points to 52.7 (the lowest level since January 2015).
Markit PMI Indices
Figure 1. Markit PMI Indices
Source. Markit, Bloomberg
A slowing macro economic environment normally leads to a slowdown in companies’ earnings which has to be assessed against an outlook which is over optimistic when looking at analysts’ continuous rosy earnings outlook for the S&P 500.
Yearly S&P500 Earnings Expectations
Figure 2. Yearly S&P 500 EArnings Expectations
Source. Bloomberg
From the graph above it is clear to see that analysts always start the year with earnings expectations which are wholly optimistic and these earnings expectations have to be scaled back as time moves on.  We always make sure that we use conservative assumptions in our earnings forecasts and don’t fall victim to having rose tinted spectacles on when assessing a company’s long term earnings power.
How do we react to slower growth environment?
Even though the vast majority of our time is spent analysing businesses and making informed investment decisions based on our detailed analysis a cyclical slowdown in the wider economy will affect most businesses one way or another and we have to position our equity exposures in the fund accordingly.
Lately we have sold out of Yum Brands, PayPal and Samsung Electronics after very healthy gains.  Our decisions are based on fundamental stock analysis when companies are trading at or above our assessment of intrinsic value. The benefit of raising cash in the portfolios at a time of elevated stock market valuations will give us more flexibility in the latter part of the year if investors get concerned or even panicked around the summer earnings season.
At the time of writing, a name like PayPal is down 8% and Stryker is down 5% respectively as the market digests the companies’ latest earnings results released on the 21st of July.  We have no exposure to these names at the moment but any further overreaction in high quality businesses such as these could give us an opportunity to invest in them at more attractive levels.
A good example of stock volatility which has worked in our favour is illustrated by looking at Microsoft’s trading pattern over the last 18 months. We invested aggressively in the earlier part of 2015 in the low $40’s and exited the position completely at the end of October last year after very healthy gains.  Earlier this year the stock drifted below $50 and we started building a position of up to 4.5% today.  Results released this week point to a very healthy business growing at reasonable levels in its core divisions.  It is pleasing to see that the stock has moved from $50 to $56 over the last few weeks and we believe the intrinsic value is closer to $60 where we will reduce our exposure again.