By Jane Wallace Current market valuations are justifiable and can be sustained, according to Baring ...
By Jane Wallace
Current market valuations are justifiable and can be sustained, according to Baring Asset Management. Speaking at the Baring Global Investment Conference, Michael Hughes, member of Barings' Strategic Policy Group, said that the productivity gains created by the use of new technology supported the level of equity valuations, even if they looked extreme by past standards.
He said: "The median US P/E ratio is now as low as it was during the Asian crisis in 1998. Europe is not far off its lowest level. All attention however is being focused on the outliners with extreme valuations. But if you look at the median, it is not the message you receive. The relative P/E of technology and telecoms companies is two to two and a half times the median which is not extreme."
In fact, according to Hughes, the UK is in the fourth but final stage of the bull market which goes back to 1981. During the first stage, between 1981 and 1987, inflation was brought under control, said Hughes. The second stage, which lasted until 1992, saw corporates adjusting to the new environment by restructuring. From then until 1999, the game has concerned the cost of capital. Going forward from here, the last stage focuses on growing fast.
Hughes said: "High technology combines with emerging markets to make a very powerful story. Growth can continue to surprise on the upside.
"But synchronised global growth steps up the risk of inflation. There will be at least another economic cycle before this causes a problem with supply of capital. The new growth/inflation trade-off is sustainable.."
Hughes noted that, in this new environment, the risk element in portfolio construction has changed.
He said: "In the last year we have spoken about three themes for portfolio construction. We have considered there is fundamental support for equity markets, but stock-specific risks are the most important. Finally, because there is low correlation between the bond and equity market, we can diversify risks through investing in bonds."
As evidence to support the stock-specific risk theory, Hughes said that last year the top 10 contributors to index performance in the FTSE 100 accounted for over 94% of all the gains. In the S&P 500, it was two-thirds of the gain and for the Dax it was 96%.
One question facing fund managers in this time of globalisation and higher correlation between markets is how hey can diversify a global equity portfolio. Hughes said that in the 1980s, there were more than enough diversification benefits to be had by going just to the US and a little further afield to Japan.
But, as the graph above shows, in the period between 1994 and 1999 there is much closer correlation between world equity markets. There is a dominant Anglo-Saxon centre, and Japan does not produce the benefits it did 10 years ago. Hughes said that fund managers now have to look further out to economies such as China. He recommended a larger emerging market component in a global pension mandate.
Hughes concluded that the bull market conditions to support equity markets are in place.
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