A looming “grim war for bonds”, a move from the US to more attractively valued regions and whether the S&P 500 is heading towards valuations last seen during the tech bubble, according to a panel of wealth managers.
The past few months have been turbulent ones for markets, as investors weighed up issues such as the timing of the Federal Reserve’s first interest rate increase, aggressive quantitative easing (QE) in Europe and Japan, and whether Greece will become the first country to exit the eurozone.
With this in mind, three wealth managers take a close look at the big issues most on their minds at the moment.
Psigma: Bond bubble discussions are nothing more than hot air
Tom Becket, chief investment officer at Psigma, believes that bonds aren’t stuck in a bubble and are simply bad value as a result of the collapse in yields and rocketing prices, which have been caused by zero interest rates and the deployment of QE by central banks across the world.
However, he admits that the last few weeks have been particularly unusual, following interest rates on government bonds from the likes of Denmark, Germany and Switzerland and corporate bonds from companies such as Nestle and Shell turning negative for the first time ever.
Performance of indices over 7yrs
Source: FE Analytics
“On ‘bubbles’ our view is simple: despite the fact that countries like Germany and companies like Nestle have been able to borrow for free or even been paid to do so, it does not mean there is a bubble in bonds. Nor does the fact that Mexico, a country of dubious borrowing in the past, has been able to issue 100-year bonds at yields of close to 4 per cent, mean that bonds are ‘bubblicious’. We just think they are bad value,” he said.
“With bonds, unlike equities, property or commodities, you should always know what you are going to get in the form of a nominal return, as long as default is avoided.”
Becket adds that the bad value story in relation to bonds has been playing out for well over a year, and describes the negatives interest rates experienced in February and May as “mini shocks”. While he does not think that the higher re-pricing of yields is over yet, he suspects that market interest rates may have moved far enough in the short term.
“In the medium term, we expect the upward pressure on yields to continue, and we think that February's weakness in bonds might well have been the ‘opening salvoes in a grim war for bonds’,” he added.
This view has been echoed by many investors as the bond bear market continues to show no sign of clearing. Newton’s Paul Brain recently explained his decision to slash his Global Dynamic Bond fund’s government bond weighting by 13 percentage points to just 22 per cent.
“The markets are long and wrong at the moment,” he said. “As a result we would expect to see investors sell whenever there is an excuse to do so, however slight that may be.”
James Hambro & Partners: Quantitative easing is a great opportunity to buy into developed market equities
Rosie Bullard, portfolio manager at James Hambro & Partners, says that her team has increased its weighting in regions set to benefit directly from monetary stimulus programmes. In addition, she and her colleagues have reduced their exposure to the US, a market that many investors now deem as expensive and lacking in momentum following the Federal Reserve’s decision to wind down QE.
Performance of indices in 2015
Source: FE Analytics
Despite believing that this programme has helped the US economy stabilise and create equity upside, she says that this is reflected in valuations and now sees opportunities in other regions.
“We have been putting some of the proceeds of our reduced US exposure into Europe, Japan and, to some extent, Asia-Pacific – markets in which we are modestly overweight and where we feel there are equity gains to be had as a result of quantitative easing and other stimulus policies,” Bullard explained.
However, bullishness on Japan and Europe and reservations on the US have been consistent themes among an overwhelming majority of investors. As such, an underlying fear is that buying into the regions has almost become consensus trading.
Simon Evan-Cook, a manager on Premier’s multi-asset funds, told FE Trustnet yesterday that he has some concerns that so many investors share the same sentiment.
“We would not disagree with the view that it’s a good way to be positioned, but we are wary that people are starting to position that way so we are talking a little bit more about reducing the positions that we have, although we haven’t done a great deal on that yet,” he said.
However, Bullard emphasises that despite the popular regional allocation, she maintains a long-term and bottom-up stock-picking process.
“At stock level we look for businesses in a niche or specialist area, with unique or differentiated products and services which give them strong competitive advantages and market share. We’ve found some interesting opportunities on these lines in the UK engineering sector lately, for instance, which we are currently weighing up,” she said.
Plurimi Wealth: US is approaching tech-bubble valuations – European banks are much better value
Patrick Armstrong, chief investment officer at Plurimi Wealth, says the US S&P 500 index is approaching tech-bubble valuations, while European stocks are comparatively far better value.
What’s more, he believes that financials and banks in particular are currently offering investors the best value for money.
“Central bank policy has been main driver of markets in the first five months of the year, as the European Central Bank started a quantitative easing policy, which led to a strong rally in European equities, and a weak euro. We expect a divergence between ECB and the US Federal Reserve will be the most significant factor in the second half of 2015, and extend the European equity rally, while the US lags,” he explained.
Armstrong adds that while US growth has been weak enough to postpone expectations of a rate hike from the Fed, it has been strong enough to avoid an equity sell-off, which means that the start of a rising rate cycle could well be on the cards within the next few months.
“We do not think the US equity market is pricing in a hike and US valuations are full,” he said.
“The S&P 500 is approaching tech bubble valuations on a price/ebitda [earnings before interest, taxes, depreciation and amortisation] basis – 10.3 today, vs. an all-time high of 10.7 in March 2000 – and on a price/book value basis the index is at 2.9x. These elevated valuations increase the risks of a rate hike-induced de-rating. Europe is in a completely different environment.”
Performance of indices over 20yrs
Source: FE Analytics
Armstrong believes that the ECB could well extend quantitative easing past 2016 and that this is more likely to happen than tapering the programme early.
In the last year, while the MSCI Europe ex UK index has made a positive return of 3.72 per cent, but the S&P 500 index has ploughed ahead and achieved a return of 19.22 per cent.
Performance of indices over 1yr
Source: FE Analytics
As such, Armstrong says that Europe has risen with the rally but has still remained significantly below US multiples, which could provide a stellar opportunity for investors.
“In our opinion European banks offer the best value,” he added. “Valuations for financials remain compelling, with the sector trading at a 40 per cent discount to the broad equity market on a price-to-book basis.”
“We have seen signs of growth in credit demand, and expect that proactive central bank policy will be a positive for the financial industry.”