Assuming there is no major recession within the next five years, global equity markets should perform in line with corporate profit growth, according to Fidelity International’s Jeremy Podger, should policy remain supportive of markets.
After a troubling end to 2018 for investors, global equity markets have enjoyed a somewhat strong year-to-date despite the spectre of US-China trade wars and slowing growth.
With central banks likely to step in to support economies – not least the US Federal Reserve and European Central Bank – the outlook for global equity markets could continue for some time to come.
“Past performance is not indicative of future returns, but lessons can be learned from historic market events to help investors to take a forward-looking view,” said FE Alpha Manager Podger.
“The last few years have been good for equity investors. It’s been a bull market and one that has been led by the US.
“Since the start of 2012, the S&P 500 index has more than doubled – up approximately 170 per cent, including dividends – while the MSCI AC World index is up 75 per cent – around 110 per cent on a total return basis – in US dollar terms.”
Total return performances of indices in US dollar since January 2012
Source: FE Analytics
However, the manager of the £2.7bn, four FE Crown-rated Fidelity Global Special Situations fund said that valuations have not changed that much indicating that global stocks remain at similar levels as they were five years ago.
“Technology has produced the best earnings and the best performance but has become more expensive,” said Podger. “Conversely, slower growth areas – financials, industrials and materials – have become cheaper.
“More recently, fears of impending recession have caused more money to move into perceived lower-risk high-quality companies. The premium for ‘quality’ has risen to levels never seen before, particularly in Europe.”
With markets not far off long-run average valuation levels – relative to current earnings – Podger said it is sensible to assume that equity markets will rise in line with profit growth, which should be “fairly modest” but positive assuming no major recession in the next few years. 
“The longer one’s time horizon, the more important earnings growth is in explaining market moves,” said the FE Alpha Manager. “However, over shorter periods, other factors introduce greater volatility that overwhelms the impetus from earnings, in either direction.
“In particular, money supply and the cost of money is a big driver - and this is one reason why markets made such strong progress in the first half of 2019.”
Nevertheless, looking ahead to the next five years, the Fidelity Global Special Situations manager said that there are three scenarios that could emerge.
Recession
The first scenario that Podger (pictured) said investors should consider is a recession, although it is difficult now to forecast what the catalyst could be.
The fund manager said it is difficult to quantify the risks of a major geopolitical incident although “a significant economic downturn seems unlikely in the next few years”.
“In the past, classic recessions were caused by overinvestment and declining industrial returns but there is no evidence that economies have been adding too much capacity,” he said. Indeed, healthy profit margins in many industries are evidence of this.
“Equally, a recession caused by a stressed banking system seems also highly unlikely given that around the developed world banks have rebuilt capital and a large part of the riskier assets have been removed from balance sheets and are now held by hedge funds and other investors.”
Podger said a more likely recession scenario would be a ‘Japanese-style’ recession: short downturns caused by industrial inventory cycles met with monetary stimulus and government spending initiatives.
“This can lead to opportunities to pick up oversold stocks at the gloomiest moments,” he added.
The bull market continues
Podger’s second scenario is that loose monetary policy and further easing, along with increased government spending spurs the markets on to higher valuations.
“After all,” he said, “the last five years have seen markets rise despite investors taking money out of equity mutual funds.
“Now that equities provide a dividend yield that is significantly higher than government bonds and offer some potential inflationary protection, maybe investors will allocate more to equities in the next five years.”
The manager added: “A major ‘melt-up’ in markets cannot be a central case but could be argued to be at least as likely as a major correction.”
Status quo
Finally, the Fidelity manager said that in a more likely scenario is that low global growth persists – particularly with the increased geopolitical uncertainty and trade issues – earnings can be expected to grow at a modest pace.
“Free cash flow is a positive and should continue to drive share buybacks which in turn augments underlying growth in earnings-per-share,” he said.
“In this relatively low growth scenario, we should also expect periods of volatility in markets. Rather than trying to avoid them entirely, we should be ready to look for opportunities that will be thrown up along the way.”
Podger typically buys three types companies in the Fidelity Global Special Situations fund: those that are exceptionally undervalued, those with unique franchises able to grow earnings faster than their peers, and companies undergoing corporate change that could be a catalyst for share price growth.
Performance of fund vs sector & benchmark under Podger
Source: FE Analytics
Since Podger took over the fund on 1 March 2012, Fidelity Global Special Situation has made a total return of 189.02 per cent compared with a 119.11 per cent gain for the average IA Global peer and a return of 142.23 per cent for the MSCI AC World benchmark. The fund has an ongoing charges figure (OCF) of 0.92 per cent.