Stockholm (Ekonamik) – “The powerful rebound in stocks since the start of 2019 began from a point of reduced valuations and was fueled by the recent pivot by central banks and the fact that U.S. and China were making progress toward a trade deal,” says RBC Global Asset Management’s Spring 2019 Global Investment Outlook. As a result, RBC GAM expects the rally to persist as long as earnings meet analysts’ expectations. Schroders notes that most of the value lost at the end of 2018 has been recovered. “Of the five markets in our regular analysis, even the worst of the bunch (Japan) returned almost 8% so far this year (as of 12 April). The US was the best with a 13.9% gain, an almost mirror image of the 13.7% it lost in the fourth quarter of 2018.”
Notwithstanding this enthusiasm, when surveying asset managers, Ekonamik noted a recurring concern that stocks might be mispriced and that an adjustment should be expected if not actively pursued. In Europe, political concerns remain dominant although asset managers seem to diverge in their views.
Are Equities Mispriced?
At the end of April, AXA IM‘s quant outfit, Rosenberg Equities, noted that despite central bank easing, concerns over global growth led investors to more defensive, quality equity positions, favouring companies with a record of profitability and earnings growth. The quant manager also warned against higher-than-normal mispricing in equities, noting it creates profit opportunities for active managers. The quant manager expects corporate earnings to expand more slowly due to a combination of slowing revenues, fading tax stimulus and margin pressures as labour costs rise.
“A correction looms for equities,” Pictet Asset Management warned at the end of April, agreeing with Rosenberg Equities. The thesis is that the upwards correction that took place in equity markets during the first quarter of the year was exaggerated, lifting “valuations to levels that are at odds with our downbeat expectations for corporate profit growth.” While analysts consensus forecasts expect global company profits to rise by 6% in 2019, down from 15% in 2018, Pictet AM’s “models suggest the picture could be worse than that. We expect earnings to grow by only 1% – 2% this year,” the asset manager warns.
Duncan Lamont, Head of Research and Analytics at Schroders used valuations to argue the opposite point. He noted that “the strength of performance in the early stages of 2019 means that returns, which were expected to have been earned over the medium to long term, have instead been harvested in barely three months.” According to the Head of Research, the correction “leaves less on the table for the future, and the valuation case is now a lot more subdued”.
“Despite a number of positives, the case for equities remains challenging,” noted Stéphane Dutu, Fundamental Analyst at Unigestion, who sided with the bears at the beginning of April. “As a result of the reduced pace of global growth, earnings expectations have been falling, which will be a headwind for equities. And with equity valuations already materially above their historical average, we expect that the current levels will not be sustainable in the face of declining profit forecasts.” In a May 3rd Market Views insights article, the asset manager reiterated that earnings expectations are overly optimistic given the macroeconomic backdrop.
European Equities – Political risks and Relative Value
Beyond the effects of trade wars, slowing global growth and monetary policy, asset managers also expressed concerns about the impact of local political developments in the UK, Spain and Italy on European equities. In its March Pan Europe update, Aberdeen SI found that European equities continued to rise despite these risks, noting that results are being met with volatility, reflecting increased nervousness and a greater dispersion of views among investors. Blackrock’s view of Europe from a U.S. dollar perspective over a three-month horizon showed earnings growth that was challenged by weak economic momentum and political risks. Europe is made less attractive to investors by a value bias without a clear catalyst for value outperformance, giving an upside to higher quality, globally oriented firms.
Unigestion took a different view on European political risks at the beginning of April. “We believe that European political risks have actually receded so far this year,” said Stéphane Dutu, Fundamental Analyst at Unigestion. While Brexit remains “fluid”, the risk of fiscal slippage in Italy and Spain was seen to recede following recent and upcoming improved electoral performance from fiscally conservative rightwing parties. However, the Fundamental Analyst is concerned by the “global economic slowdown, the unresolved trade conflict between China and the US, falling earnings estimates and equity valuations that are too generous”. This issues, more than local political problems, Dutu argues, warrant the defensive positioning adopted by Unigestion since the middle of last year
“If there is a silver lining in Europe, especially against low risk-free rates, it is European equity yields, in our view,” said Pierre-Henri Flamand, CIO at Man GLG and Henry Neville, analyst at Man Solutions. “There is a notable gap between the cash yield (calculated as the dividend yield and buyback yield) and the 10-year bund yield. Additionally, almost 80% of European companies have a dividend yield greater the corporate bond yield”. This relative value in Europe compares positively to the USA where “just 20% of US companies” find themselves in the same position.
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