View From The Top – an update

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.

View from the very top: equity markets have moved rapidly downwards in recent weeks as sentiment has deteriorated. A drawdown of such magnitude has been some time in coming and may endure for a while longer. However, fundamentals remain broadly unchanged in our view and this creates opportunities for longer-term investors. On a relative basis we continue to favour equities over other asset classes, particularly in Europe.

Given recent moves in equity markets globally, it may seem hard to remember that the S&P Index hit an all-time nominal high as recently as 18 September. The decline of almost 8% witnessed in the last three weeks and replicated to a broadly similar extent in every other region has inevitably sparked a sense of general nervousness among investors. With the benefit of hindsight, it may be possible to argue that such an abrupt downward move was perhaps overdue, especially since the last time such a drawdown occurred was well over two years ago, in May 2012, when Europe was still mired in crisis and Mario Draghi had yet to utter his ‘will do what it takes’ mantra.

It is possible to enumerate a whole list of reasons why sentiment has changed so quickly – stemming from concerns about growth prospects and the risk of deflation to inconsistent policy messages from Central Bankers via more exogenous fears pertaining to Middle Eastern instability and the potential spread of Ebola – but a more reasoned and fundamental analysis of the current situation suggests that the broad narrative regarding asset allocation and positioning has not changed. While it is possible that the current equity market drawdown may endure for some time further (and, indeed, it will also take time for markets to regain their recent highs), such an outcome creates a clear opportunity for longer-term investors.

The IMF may have cut its forecasts for global GDP growth, while recent economic data points have generally underwhelmed (particularly in Europe), but, as we have highlighted on many previous occasions, correlations between economic growth and stock market returns are close to zero. When we consider the outlook for equities, two things matter: valuation and earnings. Global earnings momentum has just turned positive for the first time in over three years (based on data from Credit Suisse), while the returns available to investors from owning equities relative to credit across the spectrum look more compelling than they have done for some time.

Against this background, we continue to favour a bias towards equities relative to other assets classes although we do not deny the possibility that markets may still fall further in the near-term before recovering. Drawdowns of more than 5% typically last at least a month (according to recent research by Goldman Sachs). In an environment where risk-off mentality pervades, US mega caps may provide something of a safe haven, but our preference over the medium-term remains for European equities. Relative valuation levels, superior forecast earnings growth from a lower base (US earnings are at peak levels) and the benefit of a weaker currency all support the case.

Alexander Gunz, Fund Manager, Heptagon Capital