As the third quarter of 2017 nears its close, Investment Adviser’s Taha Lokhandwala asks investment managers which asset classes and regions look attractive this year and next
Peter Elston, chief investment officer at Seneca Investment Management
UK equities: We are living in a world of weak inflation, the reasons for which are varied and complex. These pressures are easing but only slowly, meaning that real interest rates at both ends of the curve in general remain negative. As a result, if you sell equities because you think they’re expensive, you will soon realise your options are not great. This could mean that equity valuations continue to rise. In the UK, positive real interest rates are a long way off, so equities here can continue to rise.
European equities: If inflation pressures are weak in the UK, they’re even weaker in Europe. This is because unemployment in Europe has only fallen to 9.1 per cent, having peaked much later and at higher levels than in other regions. With unemployment where it is, wage pressures remain subdued. This is not the case across the board. Germany’s labour market is now quite tight, but the central bank is ultimately concerned with the eurozone as a whole, so monetary policy is likely to remain loose. Therefore, the outlook for European equities continues to be rosy.
US equities: The US economy is arguably the only one of the major developed countries that has entered the expansion phase, the point at which inflation pressures become entrenched. True, inflation in recent months has fallen slightly, but this is expected to reverse soon with the continued improvement in the labour market. I expect the Fed to continue to raise interest rates over the coming months, and perhaps even begin to shrink its balance sheet, the combination of which is likely to constrain equity markets.
Emerging market equities: It is always hard to generalise about emerging markets as it is such a heterogeneous asset class. Even the four Bric countries have little in common. That said, there are signs of improvement in a number of key emerging countries, with inflation falling where it was too high (Russia, Brazil and India) and rising where it was too low (China). Brazil appears to be getting to grips with its difficulties on the political and economic front, which will help investor sentiment. So selectively, and cautiously, I’m optimistic.
Fixed income: With interest rates negative, inflation low and the global economy making progress, the prospects for bonds in the developed world are dim. Safe-haven bonds are generally considered good insurance, but in the past this insurance has been reasonably priced. It may now be better to protect with a strong security system rather than expensive insurance. Look for safer income elsewhere, such as infrastructure and certain real estate trusts, where not only are yields higher but there is also inflation protection.
Property: I’ve never liked property, but that’s because I started my career in equities and quickly appreciated the benefits of investing in operating entities rather than bricks and mortar. That said, I think property will continue to benefit from the tailwind provided by negative real interest rates. Furthermore, we are finding interesting opportunities outside of core property, whether by geography, lot size, lease length, or property type. Healthcare, social housing and private residential real estate investment trusts can offer very decent yields.
Paul Flood, multi-asset income manager at Newton
UK equities: We retain a cautious outlook on UK equities given Brexit uncertainty and a less stable political backdrop. We advocate minimal exposure to UK financial, extractive and utility stocks. Sterling weakness has been the key catalyst for inflationary pressures, guiding a limited exposure to UK consumer firms. Look for selective opportunities in stocks that offer dependable earnings and less economic sensitivity. This said, the uncertainty surrounding Brexit has created new opportunities to invest in strong, well-managed domestic stocks with good, long-term prospects.
European equities: European equities have seen significant inflows over the course of the year following continued signs of stronger economic growth and less political uncertainty. Against this improving backdrop and the prospect of the European Central Bank tapering its quantitative easing programme towards the latter part of the year, the euro has appreciated against a basket of currencies including the US dollar and sterling which could prompt some investors to pause and reassess their exposure.
US equities: Corporate profits have benefited from dollar weakness, but markets remain fully valued and high relative to historic valuations. Stronger-than-expected GDP figures are a positive sign and could point to it being mid-cycle, rather than later cycle. It is important this continues and for corporate earnings growth to come through and justify high earnings multiples. Sector highlights include technology stocks, which would be a key beneficiary of any corporate tax reform – though this may not be as straightforward as expected.
Emerging market equities: Good inflows have helped EM outperform developed markets year to date, benefiting from dollar weakness and a stronger-than-expected Chinese economy. Relative to the US, there are valuation opportunities within markets such as India and Mexico. Domestically driven economies like India, where firms can benefit from strong population dynamics, as well as broader economic reform led by prime minister Modi, are favoured. India also offers attractive prospects in mortgage finance, given lower penetration of credit in the country has provided room for growth.
Fixed income: Fixed income is currently an unfavoured asset class. Significant parts of the global bond market still offer investors a negative yield. Investors are not being rewarded for the risk they are taking as corporate bond yields remain at near all-time lows – as do spreads above government bonds – leaving investors exposed to potential capital losses. We advise short-duration strategies to minimise interest rate exposure. Duration exposure to Australian and New Zealand government bonds could work where there is the opportunity for further interest rate cuts.
Property: Developing market retail may be better able to accommodate the global move towards online retailing. This contrasts with retail in developed markets, which have already been built out around high street models and are less favourably positioned to adapt to this disruptive online trend. It remains to be seen how UK commercial property fares following Brexit – it may come under pressure if firms move operations offshore. Asian markets offer population dynamics that are more favourable, and where a growing consumer base will help adjust to an online world.
John Stopford, head of multi asset income at Investec Asset Management
UK equities: We remain more cautious on the prospects for UK equities where returns continue to be driven by conflicting factors. The market remains underpinned by easy monetary policy and sterling weakness, both of which are less supportive given a more hawkish central bank and a stronger pound. Uncertainty around Brexit negotiations under a newly formed hung parliament remains, and evidence has emerged of more significant concerns for an economy still reliant on consumer credit and housing.
European equities: Fundamentals are continuing to improve, with strong sales growth and a generally more supportive macroeconomic backdrop. Valuations are less demanding than for the US, although the second-quarter results season was more mixed. Longer term, any normalisation from the European Central Bank through tapering is a potential headwind and, while political risks do remain, they are somewhat more contained.
US equities: Although valuations are stretched compared with history, the fundamental backdrop remains supportive and helps to justify these levels, but momentum has turned negative. Second-quarter results saw the balance of firms within the S&P 500 beat both earnings and sales estimates across most sectors. We expect a steady path on rate hikes by the Fed, though the effect of balance sheet reduction is unknown. Against this backdrop we support high-returning firms with earnings visibility that we consider to offer better long-term prospects than broader equities.
Emerging market equities: Valuations have normalised and are no longer as compelling. Earnings have bottomed out but have yet to rebound, with volumes still weak. Momentum remains positive and is not overextended, although it has moderated. In China, we have pared back our conviction somewhat, but we continue to look for companies that stand to benefit from the country’s reforms, economic rebalancing and supportive valuation.
Fixed income: Government bond yields reflect slow trend growth, loose monetary policy and low inflation expectations. We see some cyclical risks from less accommodative central banks, and prefer markets where policy is well behind the US, or priced to tighten too much. Emerging market bonds offer reasonable relative value and many of the higher yielders continue to benefit from inflation and interest rate convergence with major markets. Corporate bonds are expensive, with spreads back at multi-year lows. The fundamental backdrop is favourable, while inflows into the asset class remain strong.
Property: We continue to see opportunities across global real estate securities. Yields are reasonable in most regions, providing support to returns. Growth prospects are mixed though varying significantly by region and sector, with commercial property continuing to face uncertainty given Brexit concerns. Focus has shifted towards alternative real estate opportunities such as student accommodation, GP practices and logistics/warehouses, which offer greater certainty of regular income, some growth potential and a degree of inflation linkage.
