As the third quarter of 2016 nears its close, Investment Adviser’s Ellie Duncan asks multi-asset managers which asset classes and regions look attractive this year and next.
Vincent McEntegart, manager, Kames Diversified Monthly Income fund
With the Brexit vote out of the way, the source of UK-listed company earnings is driving share prices. Sterling weakness has been supportive for 2017 earnings-per-share estimates and is acting as a strong tailwind for firms sourcing the majority of their earnings abroad. However, domestically focused stocks have suffered in response to lower economic growth forecasts following the vote. With yields falling, we remain cautious on the outlook for financials and favour stocks with strong cash-generating abilities that can grow earnings.
European equities have recovered somewhat following the referendum, primarily on the back of a reasonable earnings season. But economic growth and inflationary pressures remain subdued, and the problems facing the eurozone’s periphery banks are unlikely to be resolved any time soon as more falls in bond yields increase pressure on financials. Hence we see the fundamentals of earnings backed by cash generation to be the key drivers of performance going forward, and we are focusing on stocks with positive earnings momentum.
We feel volatility in US markets implies too benign an outlook given the extent of political and economic risks on the horizon. This is against a backdrop of weak corporate confidence and capital expenditure, and we feel valuations are based on high expectations of earnings growth or intervention. We do not believe the required level of growth will materialise, with management guidance regarding third-quarter earnings looking negative and the impact of lower interest rates on corporate pension plans being a further drag on firms’ ability to invest.
Emerging market equities
Economic growth in emerging markets has stabilised and valuations trade at a favourable discount to developed market counterparts. Momentum has been with emerging markets recently, with earnings beating expectations on the back of rising margins and signs of top-line improvement. For this to continue asset prices and global growth need to keep ticking upwards. Herein lies the risk – too much growth is likely to choke momentum as an improving macroeconomic environment fosters the conditions for US rates to begin rising.
UK property prices have fallen in the wake of the Brexit vote, driven in part by forced selling due to retail redemptions. There is currently a short-term opportunity for investors to acquire higher-yielding, quality assets at attractive prices. The listed property sector offers a number of opportunities outside of the UK, in developed and emerging markets. Recent returns have been strong, and in a lower-for-even-longer interest rate environment this is likely to continue.
Government bond valuations continue to look stretched, with yields globally sitting at or around historic lows. Yields have been driven by technicals, with the Bank of England announcing a new monetary stimulus package in the wake of the EU referendum and monetary policy in the eurozone and Japan remaining accommodative. Credit valuations also look stretched, particularly when you take note of the potential to the downside for fundamentals.