Careful evaluation of equities called for
Hope for the FTSE to soar higher.
Value focus required in global equities.
Earnings multiples at historic highs.
A bumpy ride ahead for Euro equities and bonds.
Featuring this month’s experts:
In this monthly investment spotlight a selection of experts from leading UK wealth managers give their summary of investment tips in April 2015.
findaWEALTHMANAGER.com is a gateway to the UK’s leading wealth managers and we regularly tap their expertise for the benefit of our users. These past few weeks, the record level reached by the FTSE 100, broader market highs and the repercussions of European monetary policy have been top of the investment agenda.
Further to go for the FTSE 100?
Justin Oliver, Deputy Chief Investment Officer at Canaccord Genuity Wealth Management, says:
Some suggest the FTSE 100 could rise higher still, but investors must take account of the looming General Election and the Index’s underlying sector exposure.
While we do not believe that UK equities are overly extended at current levels, there are reasons to expect that the market may struggle to trade at a significantly higher multiple in the near future.
While the 7000 reading for the FTSE 100 might be viewed as psychologically important, and a level which the index wasn’t even able to breach during the halcyon days of the technology boom in the late 1990s, this doesn’t quite tell the whole story. It should always be remembered that this index level, which is so often quoted, is a capital only measure; it takes no account of the return which has been delivered by way of dividends. On a total return basis, the FTSE 100 exceeded its 1999 peak as far back as January 2006.
Reviewing traditional valuation metrics, depending on one’s mind-set, one can view the FTSE 100’s valuation either as broadly supportive, or a potential headwind without too much in the way of statistical chicanery. Bloomberg data indicates that the FTSE 100 trades at a headline price-earnings (p/e) ratio of just under 24 times current earnings and 14 times next year’s. Both are broadly in-line with their long term averages; the latter a little higher, the former a little lower. Meanwhile, the Shiller PE ratio, which adjusts earnings over a 10-year cycle and which is intended to smooth out fluctuations which may be caused by temporary slumps in profitability, or shorter-term cyclical support, indicates that the current ratio is below the historical average of 17 times.
That said, any assessment of an index’s apparent value needs to take into consideration the impact which may be caused by its underlying sector exposure. In this regard, the UK may be being presented as under-valued given the slump in commodity prices against the backdrop of the FTSE 100’s meaningful exposure to energy and basic material stocks. However, with 10-year Gilt yields of just 1.5%, compared to the dividend yield of 3.8% from large-cap stocks, UK equities certainly aren’t over-valued in comparison to fixed income markets. Ultimately, valuation is certainly no impediment to the UK market making further progress, and by many valuation metrics the UK is as at least attractive as the rest of Europe relative to the somewhat lofty valuations commanded by their US equivalents.
While valuations are not an impediment, neither are they so cheap as to offer much in the way of protection should risk aversion spike higher. With the General Election looming, and political uncertainty as high as it has been in over 20 years, there are valid reasons to expect that sterling could prove vulnerable.
Despite its international focus, the FTSE 100 could bear the brunt of foreign investors’ efforts to reduce their sterling exposure. Ironically, sterling weakness should only enhance the attraction of the UK market and increase its valuation appeal given the boost which would be provided to the FTSE 100’s overseas earnings.
Deputy Chief Investment Officer at Canaccord Genuity Wealth Management
A Value Tour of Global Equities
Rosie Bullard, portfolio manager at James Hambro & Partners, says:
New highs have prompted concerns that markets are looking expensive, but equity investors need to focus on value, prospects and momentum rather than simplistic labels when weighing up global opportunities.
The FTSE 100 Index finally breaking through 7000 for the first time prompted questions as to whether markets are looking expensive. With the MSCI World Index and the MSCI China Index also recently hitting new highs and resistance levels close for the NASDAQ in the US and the Stoxx Index in Europe, the question is a global one.
It therefore might be worth an equities world tour, flagging up our current views en route.
UK – underweight: UK equities may be priced a little above the long-term average, but not sufficiently to over-concern us. Our underweight position is more about protecting clients from market volatility as the May General Election looms.
US – just moved to neutral: Our US equity overweight has served clients well, but monetary easing and the slow maturing of the economic cycle are leading to higher employment and modest wage increases. The US corporate sector is showing strain from the dollar’s strength (which we think will continue).
Europe – just moved to overweight: Europe, by contrast, is demonstrably benefiting from euro weakness and we are starting to see mutual fund flows out of the US and into Europe.
The ECB has now made convincing moves to emulate the monetary policy measures already implemented in the US, UK and Japan. The initial impact was a sharp weakening of the euro, which took the edge off returns to sterling-based investors in Europe, but the investment picture now looks more attractive.
The cyclically-adjusted PE multiple (the Shiller PE ratio) for Europe is still below its long-term average, and well below that for the US. Most value is seen in large-caps at the moment and Germany looks like the biggest beneficiary of QE.
Japan – continue to be overweight: Our strategic orientation has been towards those economies in the early stages of convincing stimulus measures. We saw the benefit of this in the UK and the US; we are still seeing it in Japan. Japan’s PE remains below its 15-year average and still offers value.
Asia – just increased overweight position: We talked last month about catching ripples and how the economic success of the US is likely to cascade down, with Asia a particular beneficiary.
Emerging markets – underweight: Emerging market valuation multiples are cheapest – in part due to the influence of markets such as Russia that are cheap for a good reason.
This is a reminder that labels like “cheap” and “expensive” are not necessarily helpful. As investors we should be considering value, prospects and momentum.
Portfolio manager at James Hambro & Partners
Rational investors – Do they exist?
Chris Kenny, Investment management partner at Smith & Williamson, says:
Declining earnings expectations for US and UK companies should be ringing alarm bells for equity investors, but it seems that many are still paying top dollar to invest at the peak of the cycle.
A frequent assumption of market theory is that participants are rational investors who will act on available information to make prudent or logical decisions that will provide them with the greatest benefit.
Experience tells us that this is not always the case. Indeed, outside influences can change behaviours in ways that are difficult to explain. A recent case in point might be the willingness of investors to buy European sovereign bonds that will offer negative yields. If, in 2011, we had suggested that rational investors would buy Irish government bonds that guaranteed a loss if held to maturity many would have questioned our sanity.
And so we turn to equity markets where some of the same dissonance is appearing. Logic might suggest that an investor would be willing to pay the highest multiple of a company’s earnings when they are low and likely to grow. On the other hand, when earnings have peaked and likely to fall they should be less highly valued.
However, in the real world we see something else. Earnings expectations in the US and UK are declining. Recent data suggests the US economy is struggling to sustain its momentum, which may be down to the weather or something more ominous. Low inflation will lead to lower nominal growth in corporate revenues, and potentially lower headline profits for many companies.
So, are investors adjusting the value they place on earnings that may fall? No – earnings multiples are close to their highest levels seen in the last five years. Our “rational” investors are paying top dollar at the peak of the cycle, rather than adjusting expectations downwards.
Perhaps we should pay more attention to another market theory instead – the “greater fool theory” that the price of an object is determined not by its intrinsic value, but instead by the irrational beliefs and expectations of market participants.
Investment management partner at Smith & Williamson
Europe: A bumpy ride ahead?
Tom Becket, Chief Investment Officer at Psigma, says:
Europe’s Quantitative Easing programme is having a huge effect on both bond and equity markets, and investors may have to brace themselves for periods of heightened volatility.
The advent of Quantitative Easing is having a massive effect on European markets and moves we thought were possible in a cycle are happening in weeks. Commentators are trying to explain this by throwing up the example of QE in the US and telling us to relax, as Mario Draghi – President of the European Central Bank – will guide us to ever more expensive territory.
However, there is a major difference: when the US Fed started buying mortgage-backed securities in the financial crisis, they were buying distressed assets from cash-strapped holders. In Europe, they are buying ludicrously expensive bonds from holders who don’t know what to do with the cash. I’m starting to think that the prediction of even more negative bond yields is totally achievable, as there is soon to be an asset shortage in Europe. There will be upward pressure on equities and downward pressure on yields and corporate spreads as the retraction of €60bn of bonds each month makes it hard to invest your capital.
Markets everywhere are becoming increasingly distorted and the justifications used for moves are often spurious, at best. Nobody really cares about valuations anymore. The possibility for periods of heightened volatility is absolutely real.
So what are we doing in portfolios? We are continuing to hold those positions in European equities where we can see a long-term recovery in earnings and therefore justify further positive gains from share prices. Currency-sensitive companies and banks remain top of our lists in Europe, even after the excellent start to the year. In credit markets, we still like our positions in certain conventional corporate bonds and fully expect the scarcity premium to drive up the prices of asset-backed securities. Finally, we also favour certain distressed debt assets as a play on a long-term European recovery. It is in these areas that we see the best long-term value, although in truth, the “long term” is starting to scare us more and more due to the actions of the ECB.
Chief Investment Officer at Psigma
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