European markets started 2015 strongly, but then gave up some of those returns in the second quarter, the pullback being amplified by concurrent euro weakness.
Nevertheless, a sterling return of almost 4.5 per cent on the Euro Stoxx 50 index is not bad compared to other developed markets. The US S&P 500 index has grown less than 3 per cent, although mergers and acquisitions (M&A) has driven the Nasdaq index up almost 8 per cent.
In the UK the surprise general election result gave a fillip to the market, but the rally failed to take hold and the FTSE 100 index now sits 4.5 per cent below the new high it touched at the end of April.
Meanwhile in Asia, markets are livelier. Japan’s Nikkei 225 index is up 12.5 per cent in sterling terms (15 per cent in yen) and Hong Kong’s Hang Seng index grew nearly 16.5 per cent in the year to June 9. The Japanese market suggests confidence in the ongoing reforms of the country’s economy and corporate governance, while the Hang Seng reflects a combination of relative economic growth and a growing bubble in mainland China stockmarkets.
Mergers and acquisitions
M&A news has been supporting markets. Royal Dutch Shell’s bid for BG Group in the first quarter was joined by other high-profile and high-value deals announced in Europe and the US, such as Charter Communications’ offer to buy Time Warner Cable.
In the background, economic growth has been slowing. In the developed world, leading indicators in the UK and US point to a slowdown and Chinese growth appears set to continue to be lacklustre by its own standards. However, the outlook in Europe looks relatively better and Japan’s leading indicators show promising signs, so the global picture is not uniform.
Looking out to the second half of the year, what can we realistically expect from equity markets?
Valuations are not standout cheap on a historic view and indeed long-term measures of value are beginning to look stretched. We are not within bubble territory (with the exception of mainland Chinese markets) but this is not a time to be complacent, either.
That is not to say that equities are bound to pull back, but the valuation elastic is being stretched, so it would be optimistic to expect a sustained rally in the second half of 2015.
It is a truism to say that valuations only matter when they matter but they are good indicators of future long-term performance. Current levels suggest returns at the lower end of the range for the next few years, unless we see meaningful earnings acceleration (and, by implication, economic growth) or markets fall such that valuations settle back.
Clearly my hope is for the latter, but one ought to be mindful of the other outcome. One should not forget the impact of central banks’ monetary policies that could continue to support markets, but the law of diminishing returns does appear to be setting in.
Politics
Geopolitics adds some frisson of excitement every now and then, but in spite of the recent weakness in markets, there still seems to be a degree of complacency on the part of investors. The Greek saga continues to fascinate and the market reaction to the approaching denouement will demonstrate just how much investors have already discounted the various possible outcomes.
While it is hard to make the case for an aggressive market rally, even in the environment of equities moving sideways, there are opportunities to be had.
Investors prepared to keep doing the hard lifting can identify and take advantage of valuation anomalies. Over the next six months, simply owning a market may not be enough and to see decent returns one will need to generate alpha.
This does add an element of risk since alpha is not always positive, but the upshot is that while markets in general only promise to offer lacklustre returns for the next couple of years, it is still possible to find stocks whose value prospects offer strong growth over the same period. We may well be back in a stockpicker’s market.
Andrew Herberts is head of private investment management (UK) at Thomas Miller Investment
EXPERT VIEWS: GLOBAL EQUITIES
Gareth Lewis, chief investment officer at Tilney Bestinvest, says:
“The abnormally loose monetary policy pursued by the US Federal Reserve appears to be doing much to harm the recovery with excessive stimulus becoming trapped in the financial system through refinancing, share buy-backs and M&A, rather than stimulating the wider economy. While the market is obsessing about higher Fed rates, the rise in bond yields seen in the past two months has already tightened monetary conditions for the corporate sector, suggesting a greater headwind for US corporate earnings in the second half of the year.
Economically we see only tentative signs of recovery, with some pick-up in the eurozone and Japan being offset by the continuing slowdown in China and Asia. As a result, the case for a sustained increase in rates seems unjustified, with any increases likely to be modest and focused entirely on economies in the US and possibly the UK.”
Adrian Lowcock, head of investing at Axa Wealth, says:
“At the start of the year global markets were expecting Mario Draghi to announce quantitative easing (QE) in full. Expectations were high and investors were not disappointed by the result, with Draghi announcing a level of QE that was higher than expected. European markets had already begun their ascent in January and markets rose strongly in the first four months of the year.
Japan has also continued to shine... The huge QE that continues to drive the economy seems to be having an effect as currency remains weaker and lower oil prices are expected to boost Japan’s profitability.
In contrast, the US has had a poor six months. The strong dollar, high market valuations and below-expectations economic data led investors to steer clear of the US market and favour the relatively cheaper Europe and Japanese markets. Concerns over if, and when, the US Federal Reserve will raise interest rates have continued to weigh on the region, as have corporate profits which have come in below expectations.
The surprise that caught out many investors has been the strength of the Chinese stockmarket. While the economy is growing at a slower rate and struggles to adjust to a consumer-based market, its stockmarket has been performing well. Valuations were low and there was an opportunity for the country to re-rate.
In all of this, the UK ploughed on. At the start of the year the country was focused on the tightest run election in history, the result of which came as a surprise to many and has, even in the short term, barely left a mark on the performance of the stockmarket.”
