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Many core stock markets still trade at stretched valuations, but we are starting to identify more investment opportunities, although most of these are at a sub-regional or sector level.
US Still Looks Expensive Despite Dip
After hitting repeated all-time highs over the course of 2018, uncertainty has prevailed in US equities over the final three months of the year. This saw a partial reversal in the positive sentiment toward the outlook for US growth, a booming technology sector, cuts to the corporate tax rate and with the perception that the US stands to benefit the most from President Donald Trump’s policies regarding trade.
Concerns regarding the escalating trade wars have also impacted sentiment, as has doubt that Trump will be able to implement his agenda now that the Republicans only control the Senate. Elsewhere, the outlook for monetary policy carries uncertainty, with strongly rising bond yields at the start of the quarter – confirming the likelihood of further tightening from the Fed – being replaced in more recent times with fears of an impending recession.
While the outcomes of these issues are unknowable, in our view, valuations in US equities are not adequately compensating investors for the risk of the permanent loss of capital. Granted, valuations in US equities have improved in an absolute sense, but the asset class is expected to only slightly outperform inflation, on a ten-year view, on our analysis.
Furthermore, little has changed in terms of the asset class’ appeal relative to global peers. Indeed, these changes are insufficient to alter our view that US equities are the least attractive of the major equity regions and continue to pose the elevated risk of loss.
Europe Offers Select Opportunities
European equities have followed other stock markets lower in recent times, with the combined spectre of Brexit negotiations, less stimulatory monetary policy from the European Central Bank and uncertainty regarding to the political environment.
As such, our forward-looking expectations have improved, although caution is still warranted from a valuation perspective, with aggregate expected returns still lower than what we would consider fair. However, opportunities for superior returns remain at a sector level.
We retain our positive view on European energy companies, which continue to appeal, indeed even more so, following the 30% slump in the oil price which his impacted sentiment toward the energy sector.
Notwithstanding well flagged issues regarding Italian banks, European financials also look attractively priced, on our analysis, as do European telecoms, which have undergone a period of weakness relating to concerns around revenue trends, changing business models and a heightened regulatory environment. Nonetheless, we believe current valuations provide attractive reward for risk, with investors overly pessimistic on the outlook for the sector, in our view.
Elsewhere, profit margins in European healthcare companies remain depressed but we note that companies in this sector, especially those in the pharmaceutical space, are typically very high quality. As such, with similarly attractive valuations, we are being well compensated to back management’s ability to invest for future earnings growth.
UK Equity Fears are Irrational
As we move inside the final 100 days until the UK’s scheduled divorce form the European Union, poor sentiment continues to plague UK equities. This is an understandable response – humans do not like to feel uncomfortable when investing – but it is completely irrational to leave an asset class until certainty prevails.
With this, UK equities appear among our most attractive valuation opportunities, particularly relatively to other equity regions, with the risk of Brexit and tightening monetary policy being largely reflected in current share prices, in our view.
Said another way, while we cannot forecast what Brexit will ultimately look like, we believe that investors are being well compensated for the range of possible Brexit outcomes, notwithstanding that certain scenarios pose significant risk to corporate profitability.
That said, UK corporates remain high quality, in aggregate. Further, the UK share market is much more than a reflection of the UK economy. A significant proportion of companies in the FTSE 100 index are considered multinational, which is an area we find relative attraction.
Japanese Banks Offer Growth
Valuations in Japanese equities appear reasonably attractive, having improved over the course of 2018 as poor trade-related sentiment has created uncertainty in this export-led market. In addition to the strengthening valuation opportunity, we are further attracted to the compelling fundamentals of the asset class.
In particular, we note the focus of Japanese corporates on improving corporate governance, which typically leads to more efficient use of capital. We expect this trend to continue, resulting in better outcomes for shareholders through increased dividends and buybacks, improved profit margins, earnings growth, and ultimately return on equity.
With this in mind, we maintain a preference for domestic-facing companies, most notably financials.
