Although global growth is slowing down equities remain the right asset class to be invested in, according to Columbia Threadneedle Investments’ Mark Burgess.
Both equities and bonds had a strong run last year, with the benchmark MSCI AC World and Bloomberg Barclays Global Aggregates indices up by 19.77 per cent and 7.39 per cent respectively in dollar terms.
Looking more closely at individual asset classes emerging markets topped both equities and fixed income, although there were also strong gains in the US equity space where the market rose 22 per cent.
Performance of asset classes in 2017
Source: Columbia Threadneedle Investments
Things, however, have not been as successful this year, with many asset classes in negative territory or making minimal gains.
“Clearly we entered the year with a degree of uncertainty about the geopolitical backdrop with tensions coming out of Asia, an escalating trade war and – perhaps more importantly – a tightening interest rate policy gaining pace in the US,” said the deputy global chief investment officer. “All of that has put a bit of a halt on market returns.”
However, he said that between equities and bonds, the former remains the place for risk-on investors to park their cash, despite some risks.
“The key issue facing markets is how aggressively does the Fed tighten and how is that going to be driven by inflation,” he said.
So far the Federal Reserve’s interest rate hiking cycle has been “as close to perfect as possible”, as Hermes’ Andrew Jackson told FE Trustnet last week.
Indeed, Burgess noted that the US economy remains in “good shape”, despite the monetary policy tightening, boosted by president Donald Trump’s recent tax incentives and deregulation policies.
He said: “I would suggest that the US authorities’ implementation of fiscal stimulus at this stage of the cycle is brave and it is unusual when we are hurtling towards full employment to have that level of fiscal stimulus; but certainly that is giving the US economy an additional boost that it probably didn’t need.”
As such, the US is now the only economy which is still expanding strongly, following a period of rare synchronised growth across the world last year.
Most other countries, as the below chart shows, have peaked and since tailed off, with two heading into negative territory.
“For a prolonged period over the last 12 months we have seen a relatively unusual bout of coordinated global expansion with very strong PMIs in many of the world’s leading economies and getting up towards and going through 60 in many parts of the world signalling very strong growth,” Burgess said.
Growth of countries over 12 months
Source: Columbia Threadneedle Investments
“That pace of growth has slowed in the last couple of months and has dipped below 50 in a couple of places so, while the global economy is still expanding, it is doing so at a slowing rate and has come off the boil from the heady highs we saw earlier on this year.”
Although this may have been expected, and could be considered a negative factor for investors, there have been benefits from recent market conditions.
Positive growth has led to upwards earnings revisions from companies after almost six years of constant downgrades as weakness in the economy led to corporate profits missing expectations.
Despite missing expectations companies continued to rise as supportive monetary policy lifted equity markets, causing an expansion of valuations – and a price-to-earnings (P/E) re-rating.
“The synchronised global growth reversed that trend and we saw positive earnings revisions for the first time in a long time,” Burgess said.
“Corporate valuations started being driven by fundamentals and although that has diminished a bit, at the margin corporate profits are still beating expectations.”
As such, one of the reasons he argued that equities look more attractive than they have done for a while is because of that growth in profits.
“In terms of valuations we think that equities look okay valued,” said Burgess, although he noted that the US, which has run further than most other markets in recent years, remains the most highly-valued.
“Outside of North America I would suggest that on about 12x for the UK and Europe and less than that for Asia and the emerging markets, equity valuations are beginning to look moderately compelling,” he noted.
Within the equities space he is particularly keen on the emerging markets and Asia, despite a down year for the region in 2018.
Performance of indices over YTD
Source: FE Analytics
“They have had a stronger dollar to contend with and clearly trade wars are a pretty big deal because of the way their economies work but valuations look to us to be okay,” he said.
“We have had positive earnings revisions and you get a similar return on equity as the developed markets yet emerging markets trade on a discount.”
However, Burgess warned that the region can be more volatile – or “rock and roll” – than domestic markets, particularly considering geopolitical risks such as a trade war and a strengthening dollar.
“Profitability is robust, we are seeing decent growth coming through and we think equity markets look attractively-valued but the risk is that the trade war escalates, although this is unpredictable,” he said. “We are modestly overweight the region but acknowledge that geopolitics can have a big impact.”
His confidence stems from the fact that unlike previous crises, the fundamentals for individual countries are much stronger in most regions than they have been in the past, with less external financing, fewer current account deficits and more robust economies giving additional support.
On the flipside of the coin, Burgess said that valuations in the fixed income space remain unattractive and he is therefore underweighting the asset class.
“Credit spreads tightened pretty aggressively over the last year or so and spreads have backed-up a bit reflecting both the tightening that we reached but also some concerns about corporate animal spirits picking up,” he said.
“Companies getting involved with mergers and acquisitions and leveraging up to take each other over in a way that is potentially equity-friendly but probably not credit-friendly.
“So, valuations in credit are less compelling and where we will be placing our risk allocations would be in equities.”