The number of investors who deem developed market equities to be expensive has hit its highest level in four and half years, according to the latest CFA UK Valuations Index.
According to the report, some 62 per cent of respondents now believe the likes of UK, US and European stocks as overvalued – up 22 percentage points from 40 per cent last quarter – following a snap rally in equities since the UK voted to quit the EU during June’s referendum.
According to FE Analytics, the MSCI World index has delivered a total return of 17.77 per cent since 23 June despite the economic and political ramifications of the Leave camp’s historic victory.
Performance of index since EU referendum
Source: FE Analytics
On the other hand, though, the number of investors who believe emerging market equities (which have rallied by 25.56 per cent since the vote thanks to sterling weakness and the belief that the developing world is more insulated against from the volatility affecting developed markets) has only risen by 3 percentage points to 22 per cent.
Will Goodhart, chief executive of CFA UK, says with the fallout from Brexit still difficult to calculate, the sharpness of the recent rally and a upcoming US presidential election that is looking increasingly neck-and-neck, it isn’t too surprising investors are becoming more bearish on developed market equities.
“Our survey respondents are clearly feeling pretty anxious. It’s hard to blame them,” Goodhart said.
“Political risks have come to the fore and the economic outlook is uncertain. As the G20 recently observed, the global economic recovery is continuing, but remains ‘weaker than desirable’. Against this backdrop, bond yields continue to fall and the US and UK equity markets stand at or close to year-long highs.”
“The shift back towards a perception of developed market equities being overvalued is unsurprising. The extent and speed of that shift however was somewhat unexpected.”
There have been varying opinions reported on FE Trustnet about the recent rally over last few days.
For example, FE Alpha Manager Ben Leyland warned that the latest bull run in was being driven by a continuation of a longer term theme – the migration of traditional fixed income investors into the equity market following policies from the world’s central banks.
As such, he has upped his five crown-rated JOHCM Global Opportunities fund’s cash weighting to close to 20 per cent due to his concern that policies like QE and ultra-low interest rates have caused great distortions in the market.
“In that environment, which has been carrying on for quite a while now, then equities get expensive,” Leyland said.
“Unless you think there is a genuinely new valuation paradigm (which we don’t) then you face a world of very expensive equities and we struggle to see many stocks we like enough to have big positions in and there are plenty of stocks we don’t want to own at all at these prices.”
Conversely, though, Royal London’s Martin Cholwill told FE Trustnet that the fact many fund managers have been upping their cash levels during recent months, the chances of a significant correction are low.
Cash levels in the IA UK Equity Income and IA UK All Companies sectors
Source: FE Analytics
Indeed, our most recent study shows that cash levels across to the IA UK All Companies and IA UK Equity Income sectors have jumped to their highest point in more than three years (6.48 per cent) since the EU referendum.
“I’m sure we will see a pick-up in volatility and August’s trading volumes are low, but thin markets can also create big share price declines as well as rallies. I think a number of fund managers are also keeping a lot of cash at the moment, perhaps waiting for a buying opportunity, but that means the liquidity levels in the market suggest there isn’t going to be a huge amount of selling,” Cholwill said.
However, the latest UK Profit Watch from The Share Centre suggests investors are right to be increasingly cautious on FTSE-listed stocks.
While many stocks within the FTSE All Share have received a boost from Brexit-induced sterling weakness thanks to their overseas exposure, the report found that UK companies saw revenues fall by 2.2 per cent to £341.7bn in the last quarter while operating profits fell 3 per cent to £27.1bn, its eighth fall in nine quarters, as food retail and mining sectors weighed the index down.
Revenues within the FTSE All Share
Source: The Share Centre
“It has been a tough couple of years for UK plc, battling against global economic headwinds, and sector-specific problems that have beset commodities, energy and food retailers,” Helal Miah, investment research analyst at The Share Centre said.
“Supermarkets have had a particularly difficult time of it, facing intense price pressure and competition from discounters. Meanwhile, companies exposed to UK consumer spending, bolstered by a burgeoning UK economy, have broadly seen stronger growth. The Brexit vote has turned this on its head.”
Nevertheless, while the wealth manager Whitechurch Securities says the now isn’t the time to be overly bullish on equities given the recent rally (and the fact the UK equity market is now on a P/E ratio of around 20 times), there is little reason to hoard cash following the Bank of England’s decision to slash interest rates and embark on a new QE programme.
“We have implemented strategic and tactical changes to portfolios in recent weeks and are now clearly focused on interest rates remaining at very low levels for a prolonged period of time,” Whitechurch said.
“Given the ongoing short-term UK economic outlook it is prudent to reduce exposure to assets that are reliant on the domestic economy, and reduce cyclicality of portfolios. However, solid dividend producing shares at home and overseas continue to look attractive.”
However, Whitechurch warns that over the coming few weeks when market participants return from their summer breaks, trading flows increase and more attention is given the growing possibility of Donald Trump as US president, then a correction could well be on the cards.
“Whilst markets are ‘making hay while the sun shines’ at the moment, it is important not to become complacent,” Whitechurch said.
Performance of index over 2yrs
Source: FE Analytics
“The Vix index, which measures volatility of US shares and is widely known as a benchmark for investor fear recently hit the lowest level for two years. This seems somewhat complacent given the continued global economic and political uncertainty.”
