Markets need handling with care
WHILE global equities still offer good investment opportunities, they should be handled with care following the recent strong rally, according to Coronation Fund Managers.
Head of global developed markets at Coronation, Louis Stassen, says the continued policy accommodation by central banks, combined with the dramatic fall in the price of oil, saw global equity markets being driven to record levels of late. According to Stassen, the ECB’s announcement to pump $1.1 trillion into European bond markets,
LAST Sunday marked the sixth anniversary of the start of the global equities bull market, making it the third longest in US history. While investors are showing some signs of caution, the market shows none of the characteristics that have typified ‘mature’ bull runs in the past.
STANLIB retail director Paul Hansen points out that usually by this stage, national economies would be overheating with rising inflation prompting rates hikes. Instead, many economies including Poland and Australia are still cutting rates.
“Though there’s economic growth it’s lacklustre, with the one exception of the US economy. Many economies are struggling, for instance, with the European Central Bank (ECB) still implementing stimulus measures. Commodity prices are down sharply and there is very low inflation – as a result there are currently more rate cuts than hikes taking place.
“This is a good environment for equities and property, meaning the bull market is likely to continue for some time.” He points out that the STANLIB Global Property Fund delivered a 30 percent return last year.
Anet Ahern, CEO of PSG Asset Managers, says that “given the more positive inflation outlook, a more benign scenario for local interest rates is probably more likely going forward”. She says: “We tend to look at individual opportunities and not at markets per se, but we are finding quite a few opportunities in offshore markets.
“We are still able to construct a portfolio that has an average valuation of well below that of the local and offshore markets.”
Another unusual feature of the current bull market is that it is also which comes into effect this month, has helped European equities to outperform US equities so far this year, following a very long period of underperformance. Since the start of 2015, the FTSE 100 index has risen by 6.8 percent compared to the 2.4 percent increase in the S&P 500 index. On the flipside, says Stassen, the US Federal Reserve is ready to start its process of normalising interest rates; a process that is required to restore the long-term health of the global financial system. more than three years since there has even been a correction of more than 10 percent, at least in the US. There are other oddities of this bull market. For instance, Hansen says that in what has been a strong bull market, last year it was government bonds which produced the best returns despite having been massively out of favour as an asset class.
Ten-year bond yields have halved over the past year to 1.41 percent in Italy and 1.37 percent in Spain (from 3.5 and 3.4 respectively), and as a result 10-year German bonds (current yield: 0.38 percent) delivered a 36 percent return last year.
He notes that for this reason some Fixed Interest fund managers are investing in stocks just to access their dividend yield. Some European bonds have negative yields – you pay the German government to hold some bonds.
This is attracting more capital into equities both in South Africa and offshore, says Hansen, as the dividend yield of many stocks is above three to four percent. “Even at fairly high prices equities still look attractive when the dividend yield alone is more than the yield on ten-year bonds.
“In the US during January, the average dividend yield went higher than
Against this background, he says that Coronation is somewhat more cautious with respect to global equities than in the recent past. “Except for the US, we haven’t witnessed the decent recovery in earnings that is needed to justify the current levels.” As a result, Coronation has marginally trimmed equity exposure within its global multi-asset bond yields, and that rarely happens. When it does occurs, US equities generally do very well.” The average yield on European stocks is three percent with the top 50 stocks half a percent higher.
Ahern says on asset class selection: “While we do not invest based on macro themes, we are always taking changing conditions into account when we analyse investment opportunities. However, it is the valuation and changes to the risks inherent in the business rather than changing economic conditions that will make us rethink an investment.
“Having said that, the one area where we have had a rethink has been on the fixed income front, adjusting some of our valuations due to a more positive outlook for inflation. This has lead to us taking advantage of some attractive yields on medium term paper.”
Some asset houses such as Allan Gray view the US market as expensive, while Hansen points out that US quants analyst Garzarelli rates the US market as 0.8 percent under-valued, “not even fair value, never mind over-valued”, he says.
Quantitative easing (QE) is to be implemented by the ECB this week even though the EU economy is starting to look more promising, and Hansen views this as favourable for equities. EU unemployment is at a three-year low and it was recently announced that German retail sales were 5.2 percent up year-on-year.
“QE in EU is attracting a bit of attention and is positive for markets. Even without it, EU markets have recently been doing very nicely off a low base. Any chance the euro could appreciate would make European shares all the m ore attractive given their lower valuations than the US.”
February delivered an exceptionally good set of equity returns, something Hansen describes as “a delayed story”: it is a delayed recovery from last year’s 10 percent correction, while the usual year-end rally did not occur until February, he explains.
The JSE ALSI is trading at 18.2 times earnings over the past 12 months, the same as the S&P 500 Index, and well above the 14.5 times average of the past 20 years, with earnings forecast to grow at just 6 percent in 2015 (low relative to the historic average of 15 percent).
As to how this influences the decision to invest onshore or offshore, Ahern states: “We look at global and local shares with the same process and philosophy. What this means to us is that some of the larger shares in the South African market are getting expensive, making the index appear expensive.
“At the same time, we are finding opportunities in some of the lesser favoured areas of the domestic market, such as resources and mid to smaller companies.
“As far as offshore is concerned, the two best things about researching the offshore markets are the much wider opportunity set and the increased opportunity for diversification into companies that we just are not able to invest in locally.” spect to government bonds. “We believe that bonds would only start to show value in case of deflation, which remains a slim possibility.” As such, he says Coronation has hedged out the bulk of the interest rate risk within the credit portions of their global multi-asset funds.
As at end January 2015, all five of its flagship international funds were ranked in the first quartile of their respective Morningstar categories since inception.
“We only invest in assets that are trading at a discount to our assessment of their fair long-term value. One such example is our alternative asset management businesses. Alternative asset managers typically invest in private equity, physical property, debt or hedge funds on behalf of their clients. The investment industry’s allocation to these managers is very small; however, pension fund and investment consultants are indicating they want to dedicate significantly more capital to these managers over the next seven to ten years,” explains Stassen.