This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Shaun Port, CIO of Nutmeg outlines is outlook for global stock markets for ISA investors.
UK
The UK economic recovery has surprise many commentators over the past six months, seeing the one of the greatest upgrades to economic forecasts in the world. We think investors shouldn’t overlook the UK market when building their portfolio, not least because investing in UK stocks involves no currency risk. We prefer mid-sized companies, which have a greater focus on the domestic market than the FTSE 100. International buyers of the UK market have become even more important - US investors bought a record $97bn of UK stocks in 2013 – while UK pensions schemes continue to dump stocks. As a result, investors should be somewhat watchful of the emergence of political risk in the UK as we get closer to the Scottish Independence vote in September and the general election in May 2015, which spook overseas buyers of UK stocks.
US
On many measures the US stock markets look expensive compared to history, but we still think investors should have some exposure. Despite a very strong gain in 2013, we would also hold exposure to a diverse range of smaller companies, to benefit from improving domestic growth. Arguably the US market is safer than other stocks. In the majority of the 15 sell-offs we have experienced since 2009 – when the market dropped by 5% or more – US stocks have fallen by less than elsewhere.
Europe
In ‘Austerity Europe’ policymakers have been forced to react and engage in difficult reform. Wage costs have fallen sharply which has restored international competitiveness. We particularly like Italy, where the new government has radical plans to restore growth and yet the equity market is cheaper than emerging economies with difficult political problems such as Egypt and Turkey.
Japan
We are still very positive on the outlook for Japan, despite registering the worst performance of developed markets so far this year (-10%). Property prices have started to turn up after an almost uninterrupted decline since 1991 and, most importantly, the government will do whatever it takes to ensure a stable recovery.
April is crunch time for Japan. Despite slower economic growth, the government still implemented a 3% rise in VAT. We expect the Bank of Japan to ramp up its stimulus programme in May or June, weakening the yen further and boosting company profits. Given the moves to weaken the yen and the strength of sterling, we would invest in a ‘currency-hedged’ fund to eliminate losses from the weaker currency – without hedging the currency, the return from Japan for UK investors would have been cut by 25% in 2013.
Emerging Markets
Growth in emerging markets is lacklustre, partly due to the weakness of Chinese growth. Many countries have become addicted to growing commodity exports and higher prices, a trend which had evaporated over the past two years. The Chinese investment boom has passed its peak. While mining companies have recently started to take the knife to big capital spending projects, most commodities have ample supply even if emerging market growth bounds earlier than expected, so we do not expect rising commodity prices to lift emerging market stocks.
Without significant reform, many emerging markets are exposed to the US scaling back its bond-buying programme. Investors should select markets on an individual group – rather than buying ‘BRIC’ or ‘Asia’ – because individual country dynamics are very polarised. We particularly like Korea, as a good way of benefiting from economic momentum in Europe and the United States. Korea does not share the weaknesses of the many emerging markets, but it has suffered from the fall-out. Because Korea is the largest country in emerging market indices, it has seen disproportionate selling. While still classified in the Emerging market universe, Korea has many characteristics of a developed equity market. It has large currency reserves, a current account surplus and growth is accelerating – features which make Korea stand out as a good investment. Despite these strengths, the market is exceptionally cheap – Argentina and South Africa are more highly valued. Companies like Kia, Hyundai and Samsung trade at five, six and seven times expected earnings for the next 12 months, respectively. Only in Chinese Banks and energy companies in Russia and Brazil do we see comparable low valuations.
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