As we come to the end of the first half of 2016, what does the next quarter hold for investors? Investment Adviser asks some multi-asset managers for their views on the main asset classes
John Stopford, co-head multi-asset, Investec Asset Management
UK equities
The current economic expansion is likely to continue making us constructive towards cyclical assets, such as equities. That said, we expect growth to remain lacklustre. This will support higher yielding stocks and higher quality companies. Equity valuations are fair rather than cheap, but valuation is only really important at extremes. Although the UK is currently subject to ‘Brexit’ risk, assuming that the electorate votes to remain in the EU, we see opportunities in domestically orientated equities, where valuations are reasonable.
European equities
We are less constructive on stocks in Europe outside the UK. Valuations are positive, and the economic backdrop has been on an improving trend, which should help earnings, but momentum signals have deteriorated and quality measures are neutral, at best. Within Europe, there is a disproportionate number of opportunities within Scandinavia, including quality franchise businesses and Nordic banks, which we view as the most attractive area within the global banking sector.
Emerging markets
We see potential for selective emerging market equities to deliver decent returns, albeit with high levels of volatility. Valuations are attractive and quality metrics are now on an improving trend. Cyclical drags from weaker commodity prices have faded – especially from oil, where supply adjustments should underpin higher prices in the medium term. China remains a concern, given an unbalanced economy, but the authorities will be able to avoid a hard landing. In emerging markets, we prefer defensive sectors, but this is slowly changing.
US equities
The US equity market scores poorly on the measures we focus on. In particular, the stockmarket is relatively expensive. That said, the US remains the most dynamic and innovative of the major economies and, at an individual stock level, we can find plenty of attractive names. The aggregate scores are dragged down by energy and healthcare, with other sectors offering better potential. A re-rating of the energy sector is largely dependent on the extent to which prior weakness in the price of oil, and strength in the dollar, reverse.
Property
We expect property to continue to benefit from rental growth in the Anglo Saxon and European economies, but are cautious towards Asian real estate. Leverage is low, balance sheets are in good shape and borrowing costs are attractive. Yields, however, are fair with limited scope for further re-rating. Limited supply and ongoing demand should underpin current pricing. Although UK property should rebound if the UK votes to remain in the EU, concerns over Brexit mask deeper issues regarding London property.
Bonds
Government bond yields will be held down by weak trend growth, low inflation and central bank support. Valuations are moderately expensive, especially in the US and UK, and the US Federal Open Market Committee may raise rates faster than market pricing. Corporate bonds appear fairly valued, and leverage ratios suggest pressure on credit quality, but ECB buying and low interest rates are helping to maintain demand for new issuance. Emerging market debt looks fairly cheap, but this is largely deserved and exposure should be selective.
Sheldon MacDonald, senior investment manager, Architas
UK equities
UK GDP has fallen slightly in 2016, in line with market expectations. What it shows is that the unprecedented fiscal and monetary stimulus to create a backdrop of improved growth is not working. Uncertainty caused by the EU referendum is an issue. Brexit uncertainty looks set to slow growth in the second quarter as investment intentions are put on hold and consumers adopt a more cautious stance. Overall, we remain cautious on equities and are focusing on defensive income names while UK and global growth splutters.
European equities
Growth in Europe is marginally slower, but consumer spending should benefit from falling unemployment. Despite its unprecedented size, the recent ECB monetary stimulus package had a limited impact on markets and the euro is appreciating. We believe that political risk is increasing and this is not sufficiently priced in. The market should worry more about the migrant crisis, Brexit and an EU-IMF rift over Greece.
Emerging markets
Current valuations in emerging markets are at attractive levels relative to developed markets, although specific risks still remain and we do not yet see this as a real buying opportunity. In Latin America, weak commodity prices and tighter monetary policies are hurting returns. Despite recent investment inflows into emerging markets due to the rising oil price, we remain cautious. Value has rallied hard from a low base but this is not expected to last. We are maintaining a moderate underweight with a preference for Asian emerging markets.
US equities
The economy has been hit by a stronger dollar and weak demand for manufacturing. First quarter earnings may have beaten expectations but, with forecasts having been downgraded, this was a low bar. The consensus now is for earnings and revenue growth not to turn positive until the third quarter. Those predicting a US recession were negative but, on the other hand, we don’t expect a big bounce any time soon. We are maintaining a moderate underweight to the US while favouring large-cap, quality stocks with a domestic bias.
Property
The property sector remains supported by improving economic growth and a general hunt for yield. While the ‘lower rates for longer’ theme is supportive for the sector, potential rate rises may reduce attractiveness. Yields have continued to compress but remain relatively attractive versus gilts and equities, and the sector continues to see positive inflows and positive sentiment, although we see this softening from the end of 2016 into 2017.
Bonds
The global economy is normalising, as are yield curves. However, overall valuations are not compelling. Some investors are adding to duration as a hedge against continued deflation. We have a preference for less interest rate duration and more credit duration. Within high-yield we saw significant inflows from mid-February but, more recently, there have been outflows following strong performance from the asset class. We are maintaining a modest overweight with a preference for Europe over the US.
Paul Flood, portfolio manager, multi-asset team, Newton Investment Management
UK equities
With the UK referendum on membership of the EU in investors’ minds, many global fund managers have reduced exposure to UK equities, leaving a number of these companies looking attractive relative to global opportunities. With betting firms predicting a victory for the ‘Remain’ campaign, we may see a move back to domestic UK equities following the vote and a pick-up in economic activity which has been delayed in view of the uncertainty. Overall, a positive view.
European equities
The European equity market is full of financial firms that must recapitalise their balance sheets, as well as industry stalwarts that are being subjected to abundant capacity caused by QE and low interest rate policies. However, some areas of the market will prosper from the changing dynamics, particularly companies that can benefit from ageing populations and the increased migration from the Middle East. Valuations are attractive in a global context, and there is opportunity for improvement outside the financial and industrial sectors.
Emerging markets
While some countries have suffered as a result of lower oil prices, this environment bodes well for some net-importing oil economies. India and Mexico are making the right decisions for long-term economic development. Georgia is in a favourable position, benefiting from China’s revival of the ‘Silk Road’ and ties with Iran, where sanctions are loosening. However, concerns remain, such as the structural challenges in China. We are negative overall owing to the dependence on commodities, with overweight positions in select countries.
US equities
The US market is one of the most highly valued at headline level across the globe. But it is also one of the most dynamic economies, where businesses can evolve and benefit from technological advancements rapidly. Overall, it is a mixed affair with lofty valuations and historically high profit margins set against the stability of earnings from some high-quality companies in a low-return, uncertain backdrop.
Property
Western property is facing headwinds owing to challenges identified by our ‘net effects’ theme, as more retail business is moving online, making many high-street and industrial buildings redundant. In the developing world, much of the infrastructure is still to be built and should be more suited for the online economy. Many emerging markets are also beneficiaries of population dynamics and a rising middle class. We are overweight select emerging-market property; underweight developed-market retail property.
Bonds
Financial repression has reduced bond yields to historically low levels. With roughly 40 per cent of government bonds and 16 per cent of global bonds, including corporates, having negative yields, we see better opportunities in alternative asset classes, such as infrastructure and renewable-energy assets, which are beneficiaries of government subsidies yet can, potentially, provide three times the return. We are negative overall, but overweight Australia and New Zealand, which would benefit from a Chinese ‘hard landing’.
