LAST week, Nedbank Private Wealth invited the media to a discussion on the main issues affecting the markets, including China’s economic slowdown, Greece, US Federal Reserve policy and the pros and cons of offshore investing. Here is a summary of the “house view” on these issues from Nedgroup Investments multi-management team, presented by Andrew Yeadon, head of investments, London.
• Global macro outlook. Sluggish global economic growth is likely to continue, led predominantly by the US. Advanced economy inflation is likely to remain subdued, so interest rates will stay low for a long time. Global corporate earnings will grow, but modestly, this year and the next. Economic and central bank policy divergence will remain a strong influence on financial markets. Consensus economic growth and earnings forecasts, already less than 2% for the UK, Europe and Japan next year and just more than 2% for the US, now look optimistic, especially for emerging markets, at 5.3%.
“Double-digit consensus market earnings growth also looks optimistic,” says Yeadon, who expects that “analysts who have taken on board lower oil and commodity prices will be reflecting that in lower forecasts”.
• China. The stock market wealth effect is less important than economic growth and the exchange rate. The Chinese economy has been slowing for a while, and is likely to decline further. The likely outcome is that the yuan will probably depreciate further. There will be no quick recovery for China, or for commodity prices, forcing easier monetary policy in Japan, the eurozone and the US than was expected.
China has entered a period in which growth is going to be much lower, says Yeadon, who doesn’t think the performance of the Chinese stock market is nearly as important as the growth of the economy — “given its impact on commodities, etc”.
• Fed policy. The Fed is keen to raise interest rates when data allow as it worries about the distortions created by a zero-interest rate policy. Its focus is on jobs and wage inflation, but it’s not immune to external events — US financial conditions have tightened due to a strong dollar and weak euro, emerging markets and commodity-related currencies. The probability of a rate hike this month has fallen to less than 20%. Any interest rate rise is likely to be postponed to later in the year. Any move towards higher US interest rates will be gradual and slow, peaking at perhaps 2%.
• Greece. Recently resigned Prime Minister Alexis Tsipras has become more pragmatic and remains popular among the electorate. Likely outcome: He is re-elected as prime minister, leading a coalition of willing reformers. Greece stays on the rails with the incentive of a debt haircut/easier terms, as a reward for reforms.
• US equity. US earnings are close to trend and the historic market price-to-earnings ratio of 19 is not very compelling. Earnings have fully recovered from the lows of 2009-10. Conclusion: US equities look overvalued — “a bit expensive but not hideously so”.
• UK equity. Earnings are below trend and a historic price-to-earnings ratio of 14.6 is close to the long-run average. Earnings have good recovery potential, but oil and commodities are key sectors. Conclusion: UK equities look a reasonable bet, provided the earnings recovery happens.
• European equity. Earnings are below trend, but a historic price-to-earnings ratio of 19.6 is above the long-run average. Earnings have good recovery potential. Conclusion: European equities look reasonable, provided the earnings recovery happens.
• Bonds/duration — underweight/short. Government bonds remain overvalued and may remain so for some time to come. Treasuries/gilts — zero weight; corporate and high-yield debt — overweight corporate debt is a better option. The bank’s focus is on short-dated credit. “Historically, the low-risk asset class was bonds and cash, but increasingly bonds have come to look like the high-risk asset class,” Yeadon says, “with interest rates likely as low as they’re going to go…. And whereas traditionally, if you wanted to make a bit of money in bonds you’d go for the long bonds, because they trade at a slightly higher yield, they are also the more sensitive to changes in interest rates and so we can’t go there…. Instead, we’re focused on short-dated, higher-yield bonds … offering 3% or 4%.”
• UK commercial property. Although slowing, commercial property has further performance potential. Yield compression has been the main driver, but rental growth is taking the lead. Investors are broadening their search away from London to other big cities. The bank expects a 10%-plus total return this year and 7%-8% next year.
• China/commodity prices (not to mention excessive global debt/ demographics, etc) mean ultra-loose monetary policy will stay in place for longer than envisaged.
• Having been unusually low for an extended period, volatility is expected to be higher.
• Stocks look better value than bonds, but higher volatility should be expected.
• For those who have to own bonds, short-dated high-yield looks the best option.
• UK property has further momentum. Global real estate investment trusts look reasonable value on price to net asset value.
• The dollar and pound to stay strong; the euro and emerging market currencies are unlikely to bounce strongly anytime soon.
• Nedgroup Investments is underweight equities and bonds and overweight commercial property, infrastructure and hard currency cash.
“In today’s environment, diversification is key,” says Trevor Garvin, head of multimanagement. “There is nothing that is absolutely cheap out there, whether it be in SA or offshore. Post the financial crisis (2008) we have seen a strong recovery across most asset classes and the key thing is to diversify your portfolio to reduce things like volatility, etc. Capital protection is important too.
“Research shows most outperformance is achieved in bear markets; that if you can protect capital in falling markets, even though you might not get all the upside of a market, over time you will end up doing far better as you are coming off a higher base.”