As markets hit post-crisis highs, who’s afraid of the bogeyman?
Investec Multi-Asset portfolio managers Philip Saunders and Max King comment on investor sentiment and contrarian portfolio positioning
As the S&P 500 hits post-financial crisis highs, investor appetite for equity funds makes a cautious return and fixed income fund buying rises to its highest level since October 2010[1], Philip Saunders and Max King, portfolio managers in Investec’s Global Multi-Asset Team, note that surprisingly, the strong advance in markets has not yet led to a strong increase in conviction from investors.
Max King said, “Everyone is scared of the bogeyman in the longer term, which means that firm markets have not led to significant fund inflows or been accompanied by high volumes or volatility. Concerns about the euro zone, the global economy, oil prices and political risk have not gone away, encouraging investors to remain cautious. This, combined with the wish of many to buy on weakness, has led to a low volume, low volatility, steady advance, which we expect to continue for the time being.”
In terms of asset allocation, the managers took a contrarian stance in positioning for strong equity and credit markets at the start of the year, in defiance of the gloom and caution of consensus opinion. In the managers’ view, a steady advance is likely to take place, though they acknowledge that the path ahead maybe not be smooth.
The managers note that their proprietary qualitative scorecard, part of the investment process designed to reflect market dynamics and determine tactical positioning, shows only mildly positive results, but they believe that “the trend may be more important than the level. The score is likely to become more firmly positive in the next few months, at which point caution is likely to be justified.” Looking ahead at equity markets, King notes that, “Although equity valuations are being eroded by rising markets, they continue to be very reasonable by historic standards, with the global price/earnings ratios of 12.4 for 2012 and 11 for 2013, based on consensus estimates of 10.9% earnings growth this year and 13.4% in 2013. Moreover, downgrades to earnings forecasts are abating in both number and size, with 46% of estimate changes now upgrades. G7 activity data surprises also remain positive, pointing to an improving economic outlook.” He cautions, “However, we do not expect the upward path to remain smooth.”
Looking next to fixed income markets, the managers note that value in corporate credit has been more significantly eroded, but, based on their expectations that yields on government bonds will rise steadily rather than soar, credit still offers returns well ahead of cash. Returns on high yield and emerging market debt still look reasonable, even though these have been eroded by narrowing spreads.
“Markets are responding to rational concerns, not irrational fears,” say the managers. “The market has no illusions about the sustainability of the euro zone, but the period of grace which the ECB has bought may prove significantly shorter than expected. The rise in the oil price, if sustained, could reduce economic prospects and undermine corporate earnings, while the risk of an unexpected shock is ever present.
“Still, confirmation of what is known and discounted already will not move markets, only outcomes that are much worse than expected or significant new sources of bad news, though it should not be assumed that event risk is inevitably negative and that all unexpected news is necessarily bad. We believe that markets may continue upwards, pause for breath or suffer a setback. There is the potential for a long-term bull market in equities as current valuations are low by historic standards, economic growth is likely to result in continued earnings growth, and credit growth will eventually return, but that point could still be some years off.”
Investec Asset Management has been recognised with the 2012 Lipper UK award for Mixed Asset Group (Large) The awards are based on Lipper’s quantitative calculations of risk-adjusted performance over set time periods.
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