Supported by the policy mix
After rallying strongly since late December, global equity markets offer less potential upside given loftier valuations. However, we remain sanguine and equities are still our most significant allocation as the asset class is in a strong uptrend, but without the over-bullish sentiment which would be a red flag.
US. The Federal Reserve (Fed) has cut interest rates for the first time in a decade in a bid to add “momentum” to decelerating economy. However, given this year’s US equity rally has been driven by multiple expansion as earnings growth has slowed after 2018’s tax-cut boost, there is less headroom for continued outperformance, particularly as valuations are already approaching expensive. We remain neutral.
Eurozone. The European Central Bank has less room to ease than the Fed, but seems poised to push ahead with looser policy over coming months nevertheless. Euro zone exporters – particularly in Germany – have suffered as the US-China trade war has unfolded and the White House has still not ruled out tariffs on auto imports. Valuations are more attractive than in the US and earnings growth may be slightly higher this year – however, the above-mentioned headwinds may cap any outperformance potential. We remain neutral.
UK. UK equity markets are facing an environment of continuing Brexit uncertainty, weakening domestic economic sentiment – evident in both manufacturing and services purchasing managers indices – and slowing profit growth. However, with an uncertain Brexit outcome and weak profit growth, attractive valuations and historically high dividends are perhaps overlooked by investors, especially in a low-yield investment landscape.
Indeed, UK equities are trading at 12.4x their forward estimated earnings, roughly in line with long-term averages. That makes them considerably cheaper than US or European equity markets, which both are trading above their respective averages. Moreover, UK equities are offering a dividend yield of about 4.5% which is above its historic average, and well above that of competing equity markets. It is also significantly higher than the yield on offer from competing asset classes, such as UK government bonds, where the 10-year yield is a relatively paltry 0.52%.
Finally, the global nature of the UK equity index insulates the index somewhat from domestic geopolitical concerns – roughly 70% of revenues of the 100 largest publicly listed UK companies are generated abroad. However, those geopolitical concerns have perhaps unduly generated negative sentiment.
Should Sterling weaken further, the repatriated profits of its globally-oriented companies will grow, a clear positive. On the other hand, should Sterling appreciate markedly on a possible “Brexit” deal or similar, the market reaction may also be positive given resolution of a key source of instability. In any event, evidence suggest geopolitics is a poor determinant for long-term investment decisions, and long-term investors should focus on the valuations. We are Overweight.
Japan. Despite its many attractions – cheap valuations, improved corporate governance, central bank purchase programme – we expect Japan to continue to underperform. The government is likely to push ahead with the planned VAT hike this autumn, running the risk of provoking a recession. Moreover, the yen is modestly undervalued and prized as a safe haven. Any rise in currency will be to the detriment of the country’s large export complex.
Emerging Markets. Emerging market equities have kept pace with their developed market peers, with the singular exception of the US. In the near term, US-China tensions and sluggish trade are likely to keep it that way. This being said, China has embarked on a stimulus programme targeting the private sector which promises an improved outlook for next year. However, valuations are not particularly attractive in comparison to history and slowing GDP growth means underwhelming corporate earnings – we remain Underweight.
Rich valuations and slowing profit growth are mitigated by increasingly supportive Federal Reserve (Fed) policy and a strong domestic economy. We stay Neutral.
Weak euro, fiscal easing and European Central Bank (ECB) policy are supportive, and valuations attractive. However, the market is sensitive to slowing global trade and faces myriad risks (e.g. Italian budget, US auto tariffs). We are Neutral.
With an uncertain Brexit outcome and weak profit growth, many are overlooking attractive valuations, historically high dividends and a large-cap index largely insulated from domestic geopolitics. We are Overweight.
Despite attractive valuations, we remain cautious given the sensitivity of the market to the slowdown in global trade. A stronger yen would also be a headwind. We are Neutral for now.
Dovish monetary policies, fiscal expansion and waning dollar strength help limit the consequences of tariffs on EM growth. However, EM investors are too sanguine about tail risks, which abound. We are Underweight.
Source: Kleinwort Hambros 07/08/2019
*Duration: short = Up to 5 years, medium = 5-7 years, long = 7+ years
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.