PRICE IS WHAT YOU PAY…
London-listed companies paid dividends totalling £16.6bn in the final three months of 2016, a fourth quarter record and 11.7% higher than they returned in the same period a year earlier. This makes certain equities attractive while 10-year gilts yield less than 1.5%.
However, investors increasing their exposure to equities trading in London since the end of 2016 could be forgiven for feeling they have paid too much for what they hope will provide access to more cash and potential capital gains in 2017. The UK’s blue chip index ended 2016 on a PE of 33%, compared to an historical average of 15%.
The FTSE 100 has enjoyed a good run with the gains recorded in 2016 continuing into the new year. The index closed at 7,210 in the first week of January, an almost 20% gain year-on-year buoyed by a weak pound. It remained around this level in mid February.
US valuations do not make better reading. They currently trade on around 26 times earnings, compared to an historical average of 15.6 times.
Hedges’ decision to reduce the scheme’s exposure to equities was partly driven by the high valuation of company shares. “We thought the equity markets in January got quite high,” he adds.
He believes that equities, and not just those in the UK, look expensive. “PE ratios look ridiculously high,” Hedges adds. “They look overpriced at the moment, but the problem has been that there aren’t any other assets to invest in because most other assets look overpriced.
“The problem for investors of late is that they continue to go up,” he says. “You have had a number of record highs, but these PE ratios do not look realistic.”
Jameson does not agree, believing that equities have further to go, although he does acknowledge that UK and US shares are as expensive than at any time since the mid 90s.
“As always with markets it is a discounting mechanism and what you have not seen come through yet in any great strength are earnings upgrades,” he says.
“The other big uncertainty is around what happens fiscally and politically in the US,” he adds. “Generally, forecasters have not embedded any new forecasts in yet because they do not have any numbers to put into their models. If I am forced to give a view, I think there is still some upside in the equity markets.”
Jameson is not alone in believing that equities have further to run. “Just because something might look expensive does not mean that it can’t get even more expensive,” ponders JLT’s Will.
Shoqat Bunglawala, who is responsible for Goldman Sachs Asset Management’s (GSAM) multi-asset business outside of the US, believes that European and US equities will benefit from continuing economic growth. He does, however, warn of potential headwinds related to China’s slowdown and increasing political risk in the US and Europe.
“As a result, a number of asset classes are likely to be range bound and that includes equities,” he adds. “Therefore, we think it is important to be nimble and dynamic in your approach to trading the range because there can be temporary bouts of volatility in markets and we think that is going to be the case for equities.”
EMERGING MARKETS RETURN
For those moving up the risk curve and concerned about paying too much for developed market equities, they could always turn to the emerging markets.
These regions have suffered in recent years thanks to a toxic mix of slower growth in China and lower commodity prices. Then there is the US dollar, which the emerging markets have strong links to. If the US falls into recession or its currency weakens then there will be a knock-on effect in these markets. The threat of US protectionism under President Trump is another concern, but Hedges is bullish.
“In the longer term I would say you have got to expect that there are some value opportunities here, particularly in Asia where China is still growing,” he says. “If it is growing by 6% that is still pretty dramatic, even if it is not the figure it used to be.
“There are a host of other Asian nations that are growing and they are creating demand,” Hedges adds. “You are seeing more wealth being created there and they are going to spend money. That is more of a longer term trend rather than an immediate one.”
Nationwide Pension Fund’s exposure to the emerging markets includes infrastructure and property funds as well as investments that focus on consumer spending.
“There is potential value in creating those opportunities in an area that has a growing and wealthier middle class who are going to be spending,” he says. “These countries are getting wealthier and there are a lot of people there.”
Jameson has made what he describes as reasonable allocations to local currency emerging market sovereign debt and emerging market equities for the Church of England Pensions Board. “We are not currently looking to add any more funds to those areas, but we are still expecting reasonable returns from them,” he says.
Jameson believes that the potential political risks from the US on emerging market sovereign debt are offset by the outlook for commodities and improvements in corporate governance and what he calls the “general situation” in some of those countries.
Will adds that the emerging markets are not homogenous and that some countries in those regions are more vulnerable to economic and political shocks than others. He says that this can be quite different depending on if investors are looking at commodity exporters or countries vulnerable to movements in the US dollar.
“Arguably there are some areas where there is some value to be had,” Will says, but warns that some equities in these regions are looking “fairly fully priced,” as well.
But GSAM’s Bunglawala believes that while rises in US rates may pose some headwinds for emerging markets in the near term, on a medium term basis, given that “there has been a significant valuation adjustment in EM and an improvement in the macro imbalances of a range of emerging markets, their level of sensitivity to rising US policy rates has improved, particularly given higher levels of local debt issuance relative to dollar debt issuance. Overall, we expect EM outperformance relative to developed markets,” he says.
This is one example of where opportunities can be found among the noise of the potential political and economic shocks ahead. Dealing with volatility is one issue; finding long term, high-yielding assets is another. Members of the above pension schemes should be content to hear that fund managers are working to achieve both.
