View From the Top
Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
In the light of the recent geopolitical events and market volatility I would like to update you on our thinking and Heptagon’s portfolio positioning.
Despite a pull-back in recent days, the MSCI Global Index hit a 52-week high on 27 January and has risen 2.1% year-to-date. Confidence levels and attitudes towards risk have improved in the last few months, and it seems likely to us that the ‘risk trade’, especially towards equities, is set to remain in place for a while, implying potentially attractive returns for investors. Although the global economy still faces some major structural issues (particularly with regard to unsustainable debt and the ongoing painful process of deleveraging), which could imply a painful hard-landing over time, we can see several key reasons why riskier assets may continue to outperform in the near-term:
- Context: recent events in the Middle East will have very little impact on the near term profitability level of corporate America.
- Monetary policy favourable: in the US especially, reality (low inflation) and rhetoric (signalling from the Fed that it will do all it can to support the economy, especially in year-three of the US electoral cycle) imply that monetary policy should stay ‘market-friendly’ for a while longer. This will not only help spur consumer and corporate sentiment, but also favour equities.
- Low interest rates also mean more cash for investors in equities: record corporate cash balances imply the potential for significant and sustainable cash distributions to shareholders via share buybacks, dividends and increased M&A situations.
- The cost of capital is low too: for those large companies needing to raise capital in the corporate debt market, it is currently possible to do so at very attractive rates.
- Fiscal policy also benign for now: the extension of the Bush tax cuts helped remove a major uncertainty about which investors had been concerned. Moreover, the Obama administration now seems to be considering a reduction in the corporate tax rate.
- Valuation: equities continue to look too cheap, especially relative to fixed income markets: Currently, the return on cash is essentially zero, 10-year Treasury-note yields are 3.4%, investment- grade-bond yields are 5.5%. In comparison, for the S&P 500, the earnings yield is currently 7.5%, the free-cash-flow yield is 6.5%, the dividend yield is 2.0%, and trend growth in earnings and dividends is 5%-7%. In the light of the above, it seems to us that equities should be the allocation of choice for the few quarters to come. (please note that HY bonds are yielding 7.9% but offer little scope for further significant compression in yields).
- And, context again – play the Presidential cycle: historically, there have been very strong equity returns (albeit with significant volatility) in the third year of the presidential cycle ( 18.3% average annual return for the past 60 years).
On the negative side, we would not deny that substantial risks do exist and we will continue to monitor how these play out and when they may influence our decision to take a somewhat more cautious equity stance:
- Inflation is a problem in EM, especially China. EM equity valuations also look demanding to us.
- There is an above-average likelihood of a further deterioration in EU sovereign debt risks.
- Global current account and currency imbalances suggest that there may be a rise in protectionist sentiment / capital controls, especially in EM countries.
- And, if inflation does materialise in US, then base rates may need to rise, potentially much more quickly than sentiment is currently willing to discount.
Conclusion: risk trade on for now, but do not forget that risks remain.
With best regards, Arnaud Gandon, Chief Investment Officer; Alex Gunz, Fund Manager.
The document is provided for information purposes only and does not constitute investment advice or any recommendation to buy, or sell or otherwise transact in any investments. The document is not intended to be construed as investment research. The contents of this document are based upon sources of information which Heptagon Capital LLP believes to be reliable. However, except to the extent required by applicable law or regulations, no guarantee, warranty or representation (express or implied) is given as to the accuracy or completeness of this document or its contents and, Heptagon Capital LLP, its affiliate companies and its members, officers, employees, agents and advisors do not accept any liability or responsibility in respect of the information or any views expressed herein. Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation. Where this document provides forward-looking statements which are based on relevant reports, current opinions, expectations and projections, actual results could differ materially from those anticipated in such statements. All opinions and estimates included in the document are subject to change without notice and Heptagon Capital LLP is under no obligation to update or revise information contained in the document. Furthermore, Heptagon Capital LLP disclaims any liability for any loss, damage, costs or expenses (including direct, indirect, special and consequential) howsoever arising which any person may suffer or incur as a result of viewing or utilising any information included in this document.
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