Rising earnings are likely to continue supporting global equity market valuations in 2018 although growth may be slower than last year, according to Fidelity International’s FE Alpha Manager Jeremy Podger.
Podger (pictured), who manages the £2.5bn, five FE Crown-rated Fidelity Global Special Situations fund, said earnings growth had risen broadly in line with global markets, following years of stagnation.
As such, the manager said markets had moved from a “revaluation” phase to a new “earnings-driven” phase of growth.
And while the US earnings are forecast to grow by low double-digit amounts there are encouraging signs further afield, he added.
The Fidelity manager said investors are therefore more likely to focus outside of the US where valuations are relatively more favourable given the benign economic backdrop and strong earnings growth.
As the above chart shows, European and Japanese stocks are trading at lower price-to-earnings multiples than their peers in the US.
However, Podger warned that while earnings growth should be supportive of markets this year and into 2019, they are unlikely to rise as strongly as they did in 2017.
“Against that is the expectation of a tightening of liquidity conditions with further rate rises in the US and some ‘tapering’ of quantitative easing in Europe,” he explained.
“Meanwhile economic indicators are generally very positive, though admittedly one could worry they cannot get much better.”
The manager said it was “difficult to deny” that the low bond yield environment had influenced rising equity valuations in recent years.
However, with bonds trading at more expensive price-to-yield multiples in the US there could be some reversal of flows into fixed income strategies.
The FE Alpha Manager said other regions were also seeing similar trends “suggesting it is at least possible that with fixed income yield spreads now very compressed, investors could deploy more risk capital into equities in general in the coming year”.
He added: “Thus, at this stage I am inclined to be generally positively disposed towards European, Japanese – seeing very strong earnings growth currently – and other Asian markets and a little more cautious on the US, despite the recent boost from tax reform.
Podger said US companies were generally more expensive, more mature in terms of the profit cycle and more indebted. However, he said that should a global crisis emerge, the US market may show some of the defensive characteristics it has done in past cycles.
“In the absence of such an unforeseeable shock, it is reasonable to expect the US market to correct if and when monetary conditions are significantly tightened and earnings growth turns negative,” he said. “This will happen at some point but appears less likely on a 12-month view.”
Much of the growth in the S&P 500 last year was attributed to the FAANG – Facebook, Amazon, Apple, Netflix & Google (as represented by parent company Alphabet) – group of companies.
Performance of indices in 2017
Source: FE Analytics
As the above chart shows the S&P 500 Information Technology sub-sector was up by 36.91 per cent compared with a 19.42 per cent rise in the main S&P 500 index.
However, the strong rise in share prices has posed questions over the sustainability of current valuations.
Podger said that the upwards trend of FAANG stocks may be sustainable, noting the impact of exceptional earnings on valuations.
“This largely reflects some very powerful earnings growth so that earnings/cash flow-based valuations – relative to the broader market – are generally currently below long-term averages,” he said.
The FE Alpha manager added: “This does not mean, however, that many of the better performing names may not correct somewhat when the recent rapid growth inevitably slows down and the high profile mega-cap names are surely vulnerable in this regard.”
Podger takes a long-term approach to investment with a five-year view of markets, seeking out companies with significant potential for re-rating and divides holdings into three segments: “corporate change”, “exceptional value” and “exceptional businesses”. The manager may also use derivatives to enhance returns, de-risk or reduce costs.
The Fidelity Global Special Situations fund’s five crown rating has earned it a place on the FE Invest Approved list, with analysts highlighting Podger’s long experience in the sector.
“Jeremy Podger has a great deal of autonomy within Fidelity, given the importance to the brand of the fund he runs,” FE Invest analysts noted. “He was handed this portfolio after a period of underperformance and given free rein to refashion it, which he has done with some success so far.”
“His ability to generate returns from different types of opportunity is impressive, and testament to the skill and experience he has gathered over a long career.”
Performance of fund vs sector & benchmark under Podger
Source: FE Analytics
Since taking over the fund in March 2012 it has returned 142.42 per cent, compared with a 100.86 per cent gain for the MSCI AC World index and an 84.76 per cent return for the average IA Global sector fund.
The fund has an ongoing charges figure (OCF) of 0.95 per cent.