Upbeat outlook maintained

By KleinWB, Wednesday, 3rd April 2013 | 0 comments

The first quarter of the year turned out to be very strong for equity markets in particular. The strong returns were driven by a combination of a better macro outlook for 2013 and investors’ increased appetite for risk assets.


The MSCI World equity index gained almost 11% in euro terms (10% in local currency), though bond market returns were low, as the over 5-year eurozone bond index returned a barely positive 0.4%. There was a large return divergence across equity markets with Japan and North America leading the way with gains of almost 22% and 13% (in local currency) respectively. At the other end of the spectrum, local currency returns from Emerging Markets and the eurozone were weaker at minus 0.4% and plus 2%. In other asset classes, commodities had a poor quarter, with most indices showing small losses (though energy prices were generally up). It was a positive quarter for other familiar alternative asset classes such as Hedge Funds and Currencies.


Global equity markets bottomed approximately four years ago during March 2009 and since then - despite the persistent macro worries and crisis headlines - have posted strong returns. The bellweather S&P500 index bottomed in March 2009 and has since returned over 130%, recently hitting new all-time highs. It’s important to note, of course, that the rise hasn’t been in a straight line and there have been about a dozen falls of 5% or more along the way, including two that saw falls of more than 10%. In all cases it turned out to be the case that they in fact represented buying opportunities. Throughout that period there have been persistent predictions and highlighting of “doom and gloom”. The old adage that “The stock market always climbs the wall of worry” has yet again been validated...... so far.

Outlook

I have maintained for some time a positive outlook for both overall global economic growth and (in particular) for equity markets. This has been despite the context of a more fragile and volatile world as we recover from the excesses of the last economic cycle and the associated “brakes” applied by deleveraging and austerity. Against these headwinds, the tailwind combination of continued extraordinary easing measures from central banks and the very strong focus by companies on delivering solid and consistent earnings and dividend growth has been a winning combination! This trade-off between “growth vs. risk” has been THE driver of markets over recent years and I expect that to remain the case for the coming quarters also. I maintain an upbeat outlook and expect further gains from risk assets such as equities over the next 12 months – although on a short term outlook it seems reasonable to expect that markets may consolidate recent strong gains or perhaps correct a little. Events such as further negative eurozone headlines or softer US economic data could provide catalysts for same.

The growth outlook for the US economy has improved since my last blog. After a stronger than expected first quarter of growth, data over coming months may well be softer as the effects of the various fiscal tightening measures finally agreed by Congress at the turn of the year take hold, but we and others expect the effects to be temporary and we will see a rebound in the second half of the year and a stronger 2014 also. Elsewhere Emerging Market economies remain solid (although not as strong as in the past) and Europe remains mired in negative growth for now and will be barely positive by year end in our view. An overall “OK” growth outlook for me means global central banks will remain central to events and will maintain strong liquidity support for financial markets. Restoring growth is now the primary goal of central banks generally and, as a result, they have a tolerance for higher inflation.

On the risk side, the eurozone for us remains at the top of the list. We have recently seen another “mini-crisis” in the eurozone, as events in Italy and Cyprus have – yet again – led to concerns about the future of the eurozone. But notwithstanding the extreme events in Cyprus in particular, involving losses to depositors, capital controls, and prolonged bank closures, it still seems unlikely, on balance, that this mini-crisis will deteriorate into a “full-on” crisis, with collapsing equity markets, soaring peripheral bond yields, large deposit outflows from peripheral countries, etc. Indeed, it has been very interesting to note just how subdued the market reaction has been to the events in Cyprus (to date at any rate). This tells us, probably, that markets really do believe what ECB President Draghi said last summer, that the ECB would “do whatever it takes” to save the euro.

There is still a long way to go in this economic cycle, and I continue to highlight that unemployment around the world remains very high, and that we are generally only in the early stages of the global capital expenditure cycle. Despite gradual signs of improvement, overall spending by both consumers and corporates remains low and allows plenty of potential for pickup. This alone is a reason that the cycle has much further to play out in my opinion.

Company profits

The strong gains in equity markets over recent quarters leave equity valuations in aggregate at a small discount to what we would consider fair value. Therefore, we don’t believe that equities are “cheap” anymore. However, I remain confident that company profits will continue to grow at high single-digit levels in 2013 and this combined with attractive dividend payments combine to an attractive total return for investors. Given that there is no major valuation cushion remaining, it is absolutely crucial that companies deliver the profit growth expected from them. For the next stage of the cycle, I expect any meaningful “misses” to be heavily punished by investors.

Government bonds continue to be “bubble-like” in terms of valuation. Yields are at historic lows and at valuation levels that go far beyond levels justified by the current or future expected fundamentals.....though where have we heard this before!

In summary, the first quarter has been a very positive one and 2013 is to date a case of “so far so very good”. For your portfolios we maintain a positive mindset towards risk assets but also continue to favour the familiar themes we have argued for some time. These remain a focus on quality, cash flow, management strength and a strong focus on dividend yield and growth. As the environment remains fragile, I continue to favour such themes and not advocate a lower quality approach towards underlying investments. A short term consolidation wouldn’t surprise me but equally we would see such a setback as a buying opportunity towards higher markets over the next 9-12 months.

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