Morningstar's "Perspectives" series features investment insights from selected third-party contributors. Here, Alan Higgins, UK CIO for Coutts gives his current market views.
After the strong run in European and Japanese equities since October last year, valuations are looking stretched in some markets. What’s more, our analysis shows that the ‘Sell in May’ rubric has a decent track record and, if history is anything to go by, April could be a good time to trim equities.
We think it makes sense to reduce overweight positioning in global equities and focus on areas of better value – markets or sectors that have lagged in the recent rally and should have greater upside.
Given the dearth of good investment opportunities at present, we also think it makes sense to keep some powder dry while waiting for better and more attractively valued prospects to appear.
Unloved Banks Look Good To Us
In our Investment Outlook 2015 ‘On and Off The Beaten track’, we highlighted global banks as one such area of value within equity markets, which has more or less remained unloved since the global financial crisis.
Banks in the US, Europe and Japan should benefit from strong consumer spending over the next 2-3 years, given where they are in the economic cycle. Credit growth is picking up in all three regions, and falling unemployment should boost mortgages and lending. And banks look inexpensive by historical standards, with price-to-book values, assets minus liabilities, in the 0.8 to 1.2 range.
Still Going Against the Crowd On Russia
Another theme in our 2015 outlook was going against the crowd on geopolitical risk. While risks haven’t disappeared, the one causing the most angst heading into 2015 – systemic crisis and/or economic collapse in Russia – hasn’t come to fruition. But Russian assets remain very cheap.
The MSCI Russia index is trading at a significant discount to emerging markets as a whole, and at a lower price relative to book value than during the 2008 global financial crisis.
To find anything cheaper, you would have to go back to the 1998 crisis triggered by the collapse of hedge fund LTCM, when Russia’s equity market traded at 0.2 times book value; assets minus liabilities.
This suggests that markets view Russia’s current plight as worse than in 2008, but not quite as bad as the LTCM crisis. We think this is an overreaction. During the financial crisis, when oil prices sank to $35 a barrel, Russia had a higher ratio of external debt and its banks depended far more on short-term funding.
Since the Ukraine crisis worsened in February 2014, Russian equities have fallen sharply, and are well under half of their recent 2011 highs – in line with some of the worst geopolitical crises of the past. But our analysis shows that in 90% of geopolitical crises, markets recovered by about a third on an average three years after the event. We maintain our positive stance on Russian equities despite the continuing volatility.
Heading South For Better European Exposure
German equities have been on a tear recently, gaining 30% over the past six months, and no longer look like good value. Spanish and Italian equities have lagged behind and look far cheaper.
We have long been overweight European equities, and with the economies of Southern Europe improving, we see this as a good time to shift some of our European exposure out of Germany into Spain and Italy, both of which should also benefit from significant financial exposure.
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