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INSIGHTS
THE BULL MARKET ISNT OVER. THE BULL MARKET ISNT OVER.
ITS CHANGING. ITS CHANGING.
THREE TYPES OF COMPANIES THAT MAY BENEFIT THREE TYPES OF COMPANIES THAT MAY BENEFIT
DR. JERRY WEBMAN DR. JERRY WEBMAN CHIEF ECONOMIST CHIEF ECONOMIST
ELIOT WALSH ELIOT WALSH SENIOR ANALYST SENIOR ANALYST
Since early 2009, when many of the worlds equity markets
correctly began to anticipate the end of the Great Recession,
investors have enjoyed a remarkably pleasant ride. Of
course, there have been rough patchesdebt crises in
Europe, political impasse in the U.S., persistent deation in
Japanbut markets, especially in the developed world, have
generally responded by reaching new highs. Ive argued
previously that these strong returns may well mark the early
years of a secular bull market, reminiscent of the period
that began in the early 1980s and persisted throughout the
next decade.
Nevertheless, we must acknowledge that growth is tepid, at
best, in many parts of the world. Given how far markets have
already come, it stands to reason that a rising economic tide
will no longer lift all boats to the extent it once did.
Investors would do well to remember that GDP growth is only
an average, however. Many rms can and do prosper despite
only modest economic tailwinds. But with the easiest gains
already having been made, investors must now take a more
active approach. Specically, we must use what we know
about the unique characteristics of todays global macro
backdrop to help identify companies poised to thrive in it.
I believe the winners, given the conditions businesses face
now, are likely to be:
u Organic Revenue Generatorsrms that dont need to
expand costs much to grow sales.
u Efciency Vendorscompanies that sell efciency or
productivity to other rms.
u Innovatorscompanies whose inventions take costs out
of a process, or that have built a better mousetrap.
The secular bull market
isnt over.Global valuations
are still reasonable.
PAGE 2
Investors must actively search
for companies that can thrive.
Focus on three types of rms that
appear well suited for such conditions.
PAGE 4
But its changing. Many companies
could see protability fall as they
spend more on staff and equipment.
PAGE 3
As I noted in my 2014 Outlook, inves-
tors have treated markets appreciation
with considerable skepticism, with retail
investors remaining overweight cash and
high quality bonds, even as major equity
indices have accrued (in some cases)
triple-digit returns since the end of the
Great Recession.
1
Valuations are now
signicantly richer than they were a few
years ago, but they are generally far from
excessive, especially outside the U.S.
Bull markets generally dont end when
valuations reach their historical aver-
ages, but rather when they become
untenably high, other excesses
inventories, capital investment,
debtstart building up, recessions
loom or ination picks up signicantly.
As of early 2014, I see little evidence
of any of these conditions in most of
the developed world or much of the
emerging world.
Furthermore, stocks generally appear
attractively valued relative to bonds,
based on global comparisons of
earnings yields (the inverse of price-to-
earnings ratios) and 10-year government
bond yields.
2
And while some measures
of investor sentiment appear elevated
(a potentially bearish sign), the fact is that
only 54% of Americans reported having
any money at all invested in stocks as of
January 2014down from 67% in 2000.
3
As well see, not all equities are created
equal in todays macro environment.
And while the easiest equity market
gains are likely behind us, even modest
global growth can support rms that are
positioned for the evolving economic
environment. To gure out which rms
these are likely to be, well take a closer
look at the global economy.
What the Global Economy Is Telling Us
About Stocks
Source: Ned Davis Research, as of 3/14/14.
*Historical median P/E is calculated by taking the historical averages based on availability of sufciency of datain the case
of the United States this historical median is derived from 23.6 years of data. The Cyclically Adjusted Price to Earnings Ratio
(CAPE) is a measure of the price of a countrys index divided by the 10-year rolling average of earnings, which provides a
more stable measurement of current valuation. Each country is represented by the corresponding MSCI country index. The
MSCI country indices are market-capitalization-weighted Indices designed to measure the performance of their respective
countrys equity markets. Indices are unmanaged and cannot be purchased directly by investors. Index performance is shown
for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not
guarantee future results.
1. Source: Jerry Webman, Swimming Up the NILE, http://www.oppenheimerfunds.com, 12/9/13.
2. Source: Ned Davis Research, Earnings Yields vs. 10-Year Government Bond Yields, All Country World, as of 3/4/14.
3. Source: Gallup, 1/17/14.
Stocks Appear Attractive Globally
Cyclically adjusted price-to-earnings (CAPE) ratio as of 3/14/14
CHART 1
I Current P/E N Historical Median P/E*
E
u
r
o
p
e
e
x
.
U
K
B
r
a
z
il
S
p
a
in
J
a
p
a
n
C
h
in
a
M
e
x
ic
o
U
K
K
o
r
e
a
G
e
r
m
a
n
y
S
w
it
z
e
r
la
n
d
U
.
S
.
S
o
u
t
h
A
f
r
ic
a
I
t
a
ly
0
10
20
30
40
50x
17.5
9.5
10.7
9.3
15.3
13.4
14.2
18.9
19.4 19.0
12.8
20.5
23.2
17.9
22.4
16.5 16.5
19.9
16.9
20.2 20.2
22.8
22.2
14.7
23.9
38.8
Large Discount Modest Discount In-Line
2
the difference. If the continued moder-
ate growth I expect pushes companies
to expand to protect market share,
however, penny pinching may cease to
be an effective earnings strategy.
To boost organic growth, many rms will
eventually have to start spending money
on machines and labor. When they do,
it will probably be good for the economy
and for sales, but prot margins will likely
suffer. In the short to medium term, at
least, potentially falling prot margins
could disappoint nancial markets.
And the story follows a similar path in
Europe
5
and even Japan. The key for
investors will be nding companies
able to deliver earnings in this tougher
environment.
Currently, economic growth in
the worlds four major economic
geographiesthe U.S., Europe,
China and Japanmay be positive
(even improving in some cases), but
its hardly robust anywhere. My 2014
Outlook called for non-inationary
but lackluster expansion, or NILE, for
short, in the U.S.; sporadic recoveries
in Europe and Japan; and a policy-
driven slowdown in China (albeit still to
a relatively high growth rate). That fore-
cast still stands as we move through
the second quarter of 2014.
Naturally, in a slow-growth environ-
ment, companies that depend on
rapid economic expansion to increase
earnings are likely to disappoint them-
selves and their investors. Our job is to
identify companies that can expand at
a much faster pace than simple aver-
ages for the economy itself.
In 2014, however, the challenge inves-
tors face goes beyond simply nding
growth in a low growth world. Firms in
general have been growing prots by
restraining capital expenditures and
hiring, and squeezing their expense
lines, rather than following strategies
to expand sales. In fact, from 2008
through 2013, S&P 500 Index earnings
per share rose 118%, while revenues
per share only grew 7%.
4
Cost-cutting
and share buybacks made up most of
4. Source: Strategas Research Partners, Why Do Companies Spend Their Money? 2/19/14.
5. Source: Duke/CFO Magazine Global Business Outlook Survey, as of 12/13; OECD, Main Economic Indicatorscomplete database, Main Economic
Indicators (database), http://dx.doi.org/10.1787/data-00052-en (Accessed on 2/24/14).
6. Source: Art Steinmetz, Active Investing: The Case for a High Conviction Approach, OppenheimerFunds, Inc., 2/28/14.
Lackluster Global Growth
Year-over-Year GDP growth (%)
CHART 2
Source: IMF WEO, January 2014 (last update). Estimates may not be achieved.
I 2013 I 2014e I 2015e
0
2
4
6
8
10%
World Developed
Markets
Emerging
Markets
U.S. Japan Euro Area China
0.4
3.0
3.7
3.9
1.3
2.2
2.3
4.7
5.1
5.4
1.9
2.8
3.0
1.71.7
1.0 1.0
1.4
7.7
7.5
7.3
AN ARGUMENT FOR ACTIVE INVESTING AN ARGUMENT FOR ACTIVE INVESTING
With lackluster but non-inationary
growth unlikely to buoy equities whole-
sale, and with increasing numbers
of companies running out of ways to
bolster earnings-per-share growth
through cost cutting and share buy-
backs, I believe markets will draw an
increasingly sharp distinction between
winners and losers. Rest assured,
though: I believe there will be winners.
Well simply have to look harder to nd
them, and that means taking an active
approach to investing.
Active investing allows for greater
selectivity, which is likely to be desir-
able in the current environment.
Interestingly, a recent paper by
OppenheimerFunds President, Art
Steinmetz, found that since 1993, the
passive S&P 500 Index has underper-
formed the Lipper Large-Cap Core
category of actively managed mutual
funds over rolling three-year periods
when prot margins were declining, as
they appear poised to do now.
6
INSIGHTS 3
What investors need to look for today
are companies that (a) dont require
scorching economic growth to pros-
per, and (b) can sidestep, or even
capitalize on, the increasingly com-
mon need to spend more on hiring
and capital equipment to boost sales
(cost-cutting having nearly reached
its limit). The companies most likely to
thrive in such circumstances fall into
three broad categories:
1. Organic Revenue Generators
Firms that dont need to expand costs
much to grow sales.
2. Efciency Vendors Companies
that sell efciency or productivity to
other rms.
3. Innovators Companies whose
inventions take costs out of a process,
or that have built a better mousetrap.
Lets examine each category in turn.
1. ORGANIC REVENUE
GENERATORS
While some companies will struggle to
grow revenues without hurting prot-
ability, Organic Revenue Generators
business models and/or competitive
positions allow them to increase sales
without spending a lot on hiring or capi-
tal expenditures.
Leading global media companies are
prime examples. A small handful of
media companiesroughly a dozen
control the overwhelming majority of
content distributed worldwide. Thanks
to rising global afuence and the
widespread adoption of smartphones
and tablets, global media consump-
tion is growing rapidly, and major
media companies are meeting
this demand in part by nding inter-
national growth opportunities at a
very modest marginal cost of produc-
tion as they simply send out a few
more electrons. Notably, many such
companies need only about a third of
their cash ow to operate their busi-
nesses; the rest can go toward share
buybacks, dividend growth or other
shareholder-friendly uses.
e-Commerce leaders can increase
sales organically in a similar way.
Some have already sunk enormous
sums into the infrastructure they need
to process and ship merchandise on
a massive scale. With such assets now
in place, they may continue to take
share away from traditional brick-and-
mortar retailers globally, probably for
decades to come.
Source: Citi Research, Euromonitor, April 2013. Estimates may not be achieved. Past performance does not guarantee
future results.
e-Commerce Leaders Continue to Take Share from Brick-and-Mortar Retailers
Online Retail Sales as a % of Total Retail Sales
CHART 3
Finding Potential Winners in
Todays Environment
I 2012 I 2013e I 2014e I 2015e I 2016e I 2017e
0
2
4
6
8
10
12
14%
U.S. Japan China UK India France Germany
4
data by 2016
7
the equivalent of
250 billion DVDs worth of data. The
associated investment opportunities
are many, but in the current macro-
economic environment, certain types
of rms with exposure to the phenom-
enon would appear better placed than
others. These companies sell efciency
or productivity improvements to other
data-dependent companiesserver
farm cooling solutions, energy efcient
microchips, and the like. As the data
deluge continues to gather strength,
opportunities for such companies
should multiply.
Another class of companies, which we
call justied middlemen, also sells ef-
ciency to other rms. Frequently, they
source and distribute high volume, low
margin necessities to a large but frag-
mented base of business customers
that would nd doing so themselves
too costly or cumbersome. Take, for
example, Bunzl, a UK-based global rm
that supplies common items to grocery
stores, restaurants and healthcare-
related businesses, among others.
Its food service channel is instructive:
Bunzl buys paper bags, coffee cups,
napkins, to-go containers, and so on in
bulk and sells relatively small quanti-
ties to thousands of dispersed eateries.
These businesses couldnt function
without such supplies, but theyd nd
sourcing all of them individually both
costly and time-consuming. Bunzls
massive purchasing power and supply-
chain efciency allow it to provide these
goods protably, but at a low cost.
A broader set of Internet companies
enjoy comparable advantages. A range
of next generation Internet platforms
are poised to take advantage of a global
transformation in advertising, but they
dont need to spend much on person-
nel or capital equipment to do so.
2. EFFICIENCY VENDORS
Theres more than one way for rms to
become more efcient. If they cant do
it on their own, they can take advantage
of the products and services Efciency
Vendors offer. Lets consider two very
different examples of this category.
The worlds dependence on data pro-
cessing, analysis and storage continues
to skyrocket. We are living in the data
deluge era, with global Internet trafc
alone slated to surpass a zettabyte of
7. Cisco Visual Networking Index: Global Mobile Data Trafc Forecast Update 20122017, February 6, 2013. Estimates may not be achieved.
Internet Trac Continues to Expand Rapidly
Global Annual Network Trafc 20122017e (in zettabytes)
CHART 4
Source: Cisco Visual Networking Index, 2/27/14. Estimates may not be achieved. Past performance does not guarantee
future results.
2012 2013 2014e 2015e 2016e 2017e
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
Z
e
t
t
a
b
y
t
e
s
INSIGHTS 5
3. INNOVATORS
Innovating to grab market share and
preserve pricing power is another way
some companies can overcome the
hurdle of slow growth. This is particu-
larly true of rms whose inventions
take costs out of a process or those
building a better proverbial mousetrap.
New technologies like robotics stand
to introduce signicant cost savings
into manufacturing processes.
Lastly, remember that innovation
doesnt have to look like something out
of the Jetsons to help drive efciency
gains. Just look at the hydrofractur-
ing and horizontal drilling techniques
that have enabled the ongoing North
American energy revolution. Some of
the makers of related equipment
pumps, perforation guns, nonmagnetic
steel casingsmay prove to be among
the greatest beneciaries. Thanks to
the paradigm shift in the energy indus-
try, many of these companies may see
strong enough revenue growth to
maintain or expand protability even
if they do need to increase hiring and
capital spending.
The U.S. Has Increasingly Become a Net Exporter of Petroleum Products
Weekly U.S. Net Exports of Total Petroleum Products
(Thousand Barrels per Day) 12/31/043/28/14
CHART 5
5,000
4,000
3,000
2,000
1,000
0
1,000
2,000
3,000
3
/
2
8
/
1
4
2
0
1
3
2
0
1
2
2
0
1
1
2
0
1
0
2
0
0
9
2
0
0
8
2
0
0
7
2
0
0
6
2
0
0
5
2
0
0
4
Source: U.S. Energy Information Administration, as of 4/2/14.
6
Summing Up Summing Up
The secular bull market weve enjoyed for the past few years
isnt over, but it is changing. Investors today confront a
world of relatively modest economic growth in which equity
valuations have risen and prot margins may be peaking, as
companies increasingly must deploy capital to drive future
expansion. In such an environment, its unrealistic to expect
a rising tide to lift all boats, and investors consequently
must become more selective. This change means taking a
more active approach to investing, and focusing on types
of companies whose characteristics make them particularly
well-suited to thrive. I believe that as we move through 2014
and beyond, the advantages of Organic Revenue Generators,
Efciency Vendors and Innovators will serve investors well.
INSIGHTS 7
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DR. JERRY WEBMAN DR. JERRY WEBMAN
CHIEF ECONOMIST CHIEF ECONOMIST
Jerry Webman provides Jerry Webman provides
strategic viewpoints on the strategic viewpoints on the
nancial markets and the nancial markets and the
economy. In his career, economy. In his career,
Jerry has had roles as a Jerry has had roles as a
researcher, a nancial advisor researcher, a nancial advisor
and a portfolio manager. He has and a portfolio manager. He has
been in the industry since 1983. been in the industry since 1983.
ELIOT WALSH ELIOT WALSH
SENIOR ANALYST SENIOR ANALYST
Eliot Walsh is a senior Eliot Walsh is a senior
analyst in the capital analyst in the capital
markets research group. markets research group.
Eliot has been in the indus Eliot has been in the indus-
try since 1998.