With the successful resolution of the conflict in Iraq, a major uncertainty has been removed and vo...
With the successful resolution of the conflict in Iraq, a major uncertainty has been removed and volatility has reduced dramatically. Western equity markets have subsequently rallied more than 20% from their March lows but the outbreak of Sars has undermined the potential for a concomitant rally in Asian markets.
The Dow Jones Eurostoxx 50 hit a six-year low on 12 March at 1909. It had had risen 20.2% to 2294 by 12 May. The Hang Sen index, which has been among those hardest hit by the Sars epidemic, reached a five-year low on 25 April, falling to 8409, and had only recovered by a modest 5.6% to 8,634 by 12 May.
Investors' risk appetite appears to have increased. This is most evident in the narrowing of credit spreads and the recent performance of high beta technology, financials and small company stocks. Within our portfolios, holdings in Loomis Sayles High Yield, Schroder UK Alpha Plus and Close Finsbury Technology have added significant value over the recovery period.
It is pleasing to report we are actually making money for investors so far this year. However, before getting carried away we feel the issues surrounding corporate earnings, sales and pricing, together with corporate and consumer debt, have to be resolved.
In February, we stated that the analytical community remains too bullish, with consensus earnings forecasts too high given the expected levels of GDP. Despite downward revisions in most sectors, this is still largely the case. We also argued only a marginal improvement in capital expenditure was being seen and there were nascent signs of a slowing US consumer, which leaves risks to the downside. The economic evidence still supports this view, with few indications of any improvement in the operating environment for businesses.
It is noticeable that in the most recent statement by the Federal Reserve, concern is expressed over the possibility of a deflationary scenario unfolding. While this may have positive implications for the sustainability of current government bond yields, it does not augur well for companies' pricing power.
This will remain a pressure on corporate earnings and leave stretched balance sheets a widespread problem. Unsurprisingly, companies with positive cashflow will focus on the immediate reduction of their debt burden to the cost of current shareholders.
As a result, our longer-term thoughts still do not encourage a particularly positive view of returns for equity markets in the West and there appears to be little of real attraction other than alternative asset classes, higher yielding debt and Eastern European equities.
On a more positive tack, we should remember that stocks with good balance sheets, high and/or improving return on equity (ROE), with reasonable ratings and supporting yields can be found. The good news remains that for those who are willing to move away from consensus, substantial outperformance can be achieved in this environment. Examples of managers who fit this profile include Bill Miller at Legg Mason and Hugh Hendry at Odey.
Supportive monetary and fiscal policy.
Pockets of positive earnings surprises.
Increase in risk appetite.
Underperformance still present – for now
Regtech or fintech
15% increase in number of claims paid
Open architecture philosophy
Inflation above 2% for first this this year