Markets are entering the most challenging part of the cycle but attractive investment opportunities can still be found in several parts of the globe, according to portfolio managers at T. Rowe Price.
Following several years of relatively subdued conditions, markets have seen a return of volatility in 2018 with issues such as the Federal Reserve’s tighter monetary policy, the trade war between the US and China, extended valuations and political uncertainty being offered as reasons for the renewed turmoil.
Against this backdrop, risk assets have struggled to make meaningful progress this year. FE Analytics shows that the MSCI AC World index has made a 1 per cent gain over 2018 to date; the FTSE All Share has lost 6.78 per cent and the MSCI Emerging Markets fell 7.71 per cent; the S&P 500 is up by 7.33 per cent.
MSCI AC World’s rolling 12-month volatility over 3yrs
Source: FE Analytics
Looking ahead, Chris Alderson, co-head of global equity and head of international equity at T. Rowe Price, argued that the one of the main impacts of quantitative easing (QE) being withdrawn from markets will be investors having to re-calibrate how easy it is to make money.
Alderson, who has 31 years of investment experience and sits on the investment advisory committees for T. Rowe Price’s emerging markets, emerging Europe and Middle East & Africa equity strategies, said: “We’re heading into the hardest part of the cycle.
“It’s 10 years since the collapse of Lehman Brothers and the punch bowl is finally being taken away. This year was probably as good as it’s going to get for US earnings growth. Next year will probably remain a reasonable environment for risk assets, but not as good as it has been for the past few years.”
Arif Husain, head of international fixed income at the asset management house, added that investors need to understand how “nuanced” the situation with QE is at the moment.
In the US, the Federal Reserve has moved into a ‘quantitative tightening’ phase and the European Central Bank remains on course to do the same. However, it is unclear when the Bank of Japan plans to tighten its policy and the People’s Bank of China has “turned the money printing presses on again”.
“It’s a mixed picture overall, but I think the bottom line is that there is going to be less money in circulation – and since most of the money created by QE flowed into financial assets, that’s where it will come out again,” Husain said.
“This will not only have a profound impact on equity and bond returns, but also on volatility and correlations.”
Performance of indices over 10yrs
Source: FE Analytics
Turning to individual countries, T. Rowe Price co-head of global equity and head of US equity Eric Veiel argued that concerns about the Trump administration and associated political risk is not undermining the outlook for the US stock market in any meaningful way.
“The political situation in the US is currently creating a lot of fodder for television, but it’s not the primary driver of the US economy. The main driver is the US consumer, who is doing pretty well given recent wage growth and tax cuts,” he said.
“It’s true that valuations are high, but while valuations tend to be accurate indicators of long-term returns, they are poor at predicting returns over one or two years.”
Veiel also noted that the US economy is in “relatively good shape” and said there is “a decent chance” that US equities will continue to deliver solid returns over the next few years.
When offered the choice between Japan and Europe for the strongest investment opportunities, Alderson opted for Europe and said that, of the two, it has stronger fundamentals and more attractive valuations.
He also highlighted the fact that a number of European sectors are currently doing “very well”. He singled out healthcare as a good example, noting its companies are trading at earnings multiples in the mid-teens with healthy dividend yields and positive earnings growth; added to this, their valuations are “nowhere near as stretched” as they are in the US.
Alderson also said Japan can still be considered a good long-term prospect, as the country is undertaking plenty of small reforms are changing corporate governance in a way that should improve returns on equity.
However, T. Rowe Price’s asset allocation committee has recently taken down its allocation to Japan as it is a global cyclical economy that is likely to suffer it the global economy starts to slow down, hence his preference for Europe.
Performance of indices over 5yrs
Source: FE Analytics
On the question of whether now is a good time to invest in the developing world, which has sold off in 2018, Alderson noted that while the US is clearly at a late stage in its cycle, emerging markets are arguably very early in their cycle.
This has led to “mouth-wateringly cheap valuations” in some markets and currencies; some emerging markets are down to 2008 levels.
Husain, however, added that three things need to happen if emerging markets are to benefit from a sustained rally.
“First, there needs to be a sentiment change towards emerging markets, which has already occurred to a large extent,” he said.
“Second, China needs to demonstrate that it can maintain a stable economy in the face of potential tariffs from the US; and third, the US dollar needs to be weaker.
“The third of these is crucial – if the dollar remains strong, it will be difficult for emerging market currencies to perform, and therefore difficult for emerging market equities and debt to perform.”