Investors should sell exposure to emerging market equities in favour of developed markets, according to JP Morgan Asset Management chief market strategist Stephanie Flanders, who adds that high yield bonds could also offer decent returns following 2015’s turbulent time for most asset classes.
To many peoples’ surprise, fixed income has outperformed equities over 2015 to date despite the relative weakness of bonds compared to their recent years.
Over the past five years equities are still well ahead, having overwhelmingly outperformed bonds in most developed markets and this is reflected in the relative performance of different fund sectors.
According to FE Analytics, both the FTSE All Share and the FTSE All World Developed indices are ahead of the IBOXX UK Sterling Corporate All Maturities and IBOXX UK Sterling Gilts All Maturities indices over five years.
Performance of sectors over 5yrs
Source: FE Analytics
However, the equity indices have been flagging more recently despite a pallid performance for fixed income this year. This is largely down to a crash in stock markets around the world, the capitulation point of which has become known as Black Monday after a heavy sell-off struck on 24 August.
Flanders says returns from all asset classes are going to be low for several years especially when it comes to equites. She adds that emerging markets – which are already down 10 per cent in 2015 – are the worse place to be, compared to the UK and Europe.
“Looking in very broad terms, equities you can say are cheaper than they were. In Europe and UK we are back to a long-term average for the price to earnings ratio,” she said.
“If you look at emerging markets they are probably cheap but we think it is going to get a lot cheaper before it becomes something you want to buy.”
Flanders (pictured overleaf), who is the former economics editor at the BBC, thinks that while the sell-off in emerging markets has offered up cheaper valuations, there is the significant likelihood of further pain to come.
For all the funds in the IA Global Emerging Markets sector, 2015 has been a bad year. Not one fund is in positive territory since the start of the year with the likes of the Templeton Global Emerging Markets and Lazard Emerging Markets funds down close to 18 per cent.
Over the past six months the numbers are even worse with the average fund in the sector down by close to 20 per cent; even the ‘best’ fund in the peer group – Carmignac Ptf Emerging Discovery – is sitting on double-digit losses.
Performance of fund, sector and index over 6 months
Source: FE Analytics
Flanders said: “There is that sense that is more bad news – quite a lot – built into the price.”
Royal London Asset Management head of multi-asset Trevor Greetham (pictured) is one investor who is overweight developed market equities but underweight the emerging markets.
“We have a positive outlook for developed market stocks despite, or even because of, the emerging market slowdown. The associated fall in commodity prices is putting downward pressure on inflation,” he said.
He thinks emerging market stocks could be for similar levels of turbulence to those seen at the end of 1990s, dubbed the Asian financial crisis, when the average emerging markets fund lost almost 50 per cent.
Performance of sector in 1998
Source: FE Analytics
Greetham said: “There are strong parallels with the 1990s, a decade in which we saw a rolling series of emerging market crises in Mexico, Thailand, Malaysia, Korea, Indonesia and Russia.”
“We wouldn’t rule out a bounce in oversold emerging equity markets but to overweight them in a global context you need to believe in a sustained recovery in China or a sustained period of US dollar weakness. We don’t.”
Flanders is also tentatively expecting high yielding bonds, which have had some success in 2015, to continue to offer modest but decent returns.
“Widening credit spreads are an opportunity in the high yield sector. There is some protection from rising interest rates as it gives a bit more room for manoeuvre for fixed income investors that are looking for higher returns but also some protection from future volatility,” she said.
High yield spreads have been widening thanks to increased volatility and concern in equity markets after the well-publicised problems at major players such as Glencore and Volkswagen led to investor attention on how they will service their debt burdens.
However, Flanders thinks this panic could be the source of upside for funds wading in as the anxiety subsides.
Not all investors see opportunity here, however. David Jane, co-manager of Miton’s multi-asset fund range, warns this could be evidential of greater risks to investors.
“A broader widening of credit spreads throughout the high yield market which is worrying as widening spreads is a lead indicator of recessions,” he warned.