Investment markets 2019 Q&A (est read time: 5 mins)
In this Q&A on investment markets, our in-house investment professionals answer your most pressing questions.
- We’re entering an important period, with heightened volatility expected. This is not a time to be scared, but rather, to focus on long-term opportunities.
- The recent market rise is a peculiar one, with central banks influencing the direction. We see risks to such a move, although welcome the positive returns for our investors.
- Emerging markets have been impressive lately, which many wouldn’t have expected.
- U.S. profits have been strong, perhaps too strong, which we’d expect to moderate over the long term.
- Generating income in this environment is complex, especially when accounting for credit quality and concentration risks.
How are you positioned given all the risks coming up (Brexit, etc.)?
As long-term investors, we remain broadly defensive and aware of the risks in many key markets. That said, we’re also ready to act quickly where should opportunities for long-term gain arise.
Based on current pricing, we see greater opportunities for equity exposure in areas such as Europe (including the U.K., on valuation grounds) and emerging markets. For fixed income, we have a bias towards higher-quality issuers including U.S. government bonds, while still holding healthy cash levels.
Put together, we see scope for further market unrest but remain confident in our positioning if this occurs. We don’t believe this is a time to be scared, but rather, to seek out opportunities for long-term gains.
Why are markets jumping now? Does this make sense to you? Surely, the central banks are only changing direction due to the risk of a recession.
First, let’s set the scene. Since Christmas, we’ve seen a broad-based market rally, due primarily to the change from a tightening bias to a neutral stance by the Federal Reserve. This is considered stimulatory, at least in a relative sense, as many seemed worried about growing recession risk on the horizon.
In this way, it does seem peculiar that the value of a business grows because the economy is souring. However, it depends on the company or industry in question. Those with high debt could benefit from the extension of lower interest rates, for example. But to be sure, trying to understand markets in the short term is a bit like reading tea leaves: plausibility too often passes for proof.
We tend to view the investment landscape over a 10-year-plus horizon, where we see no need to change our stance. All risk assets have gained—not just U.S. equities—and fixed-income markets have rallied too. We welcome the positive returns, however remain cautiously positioned given the heightened risks. To us, the risks aren’t just an economic recession—there are valuation and leverage risks to be managed as well.
Why have emerging-markets stocks been so strong lately? In a sell-off, many would have assumed they would fall harder than the rest.
Perspective is important here too, as emerging-markets equities already took a hit in early-mid 2018 on concerns over the impact from a strong dollar, weaker Chinese growth, and the impact from the trade war. With this bad news mostly being priced in, it is in some ways no surprise they offered greater relative protection in the late-2018 equity sell-off. On most measures, emerging-markets valuations improved markedly overall, but we’d caveat this by saying there are great country differences as the block is very heterogenous. For example, we’re seeing greater value in countries like South Korea and Taiwan, both of which have been suffering from their more cyclical exposure to a weaker semiconductor sector, linked once again to recession concerns. We also find more value in idiosyncratic markets like Russia and Turkey, although they are not without clear risks and hence the range of outcomes in both markets is wide. The most unattractive parts remain Latin American, Southeast Asian, and Indian equities, largely on valuation grounds, in our view.
Is it reasonable to expect U.S. companies to grow profits faster than other markets?
Companies in the U.S. have certainly performed well, with strong revenue and earnings growth over the past decade. These same companies also have an impressive ability to innovate and have a strong presence in growing parts of the global economy. That said, we don’t think the recent earnings growth is likely to be sustainable. In the very long run, our analysis shows that companies in aggregate tend to grow earnings at around the same rate as the nominal economy, give or take. So, it would seem reasonable that U.S. companies will see earnings moderate. How this transpires relative to other markets is difficult to judge, as is the way one can execute on such views.
One of the biggest execution challenges is understanding what is priced in. On all valuation measures (e.g., price/book, price/earnings, price/sales), the U.S. is expensive, often by a record margin relative to other markets. This means that investors are already expecting stronger earnings growth in the U.S., which we don’t think is a compelling thesis.
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