Equities: where next after a record breaking year?

Our equities fund managers give their thoughts on what investors should look out for in the coming year.

2 minute read

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The outlook for global equities remains reasonably bright, notwithstanding the fact many markets are standing at record highs having risen at breakneck pace in 2017.

Although rising interest rates and bond yields are likely to provide a headwind for share prices, it should be remembered that central banks’ assistance is being withdrawn for a reason, namely stronger economic growth. Since that should feed through into higher profits, it ought to support share prices.

The prospects for European equities seem particularly positive given the rapid improvement in economic performance across the region, and what we perceive to be reduced political risk. The European market is trading on a forward price-to-earnings (P:E) multiple of around 151 which seems far from excessive, all the more so since economic growth within the euro zone may exceed market expectations next year.

European equities fund manager Edward Kevis believes European technology shares continue to look attractive. “Although prices have risen sharply, there is scope for further gains given the ongoing growth of the ‘digital economy’, albeit probably less than 12 months ago,” he says. Kevis also likes industrial stocks, which in many cases seem poised to benefit from the ongoing trend towards rising automation as well as the brighter economic outlook.

While there are risks to this view, especially if the world economy were to suffer an unexpected setback, he sees little merit is attempting to guard against such an eventuality at this point. For instance, he believes there is little relative value in the shares of more defensive companies given the relatively low growth rates most are forecast to achieve.  

Elsewhere, the positive economic outlook should also benefit emerging market shares. Although valuations have risen sharply, they remain at a roughly 30 per cent discount to those available in developed
markets.2 That looks excessive, especially given the pace at which corporate earnings growth has outstripped that seen in developed markets.

Emerging market fund manager Will Ballard believes the Taiwanese market, with a forward P:E ratio of 13, looks especially attractive, not least since many of the country’s exporters should benefit from stronger global economic growth. He also likes the Korean market.

“A P:E ratio of around nine looks enticing, especially with the government of President Moon Jae-in starting to tackle corporate corruption by limiting the power of the country’s five main family-run conglomerates,” Ballard says.

However, on a word of caution, it is important to note that the rally in emerging market equities has been driven largely by China, specifically some of its largest technology companies. “Their dominance as a source of returns for emerging markets is of concern,” Ballard says.

The picture is more mixed for the US. Although corporate earnings have been growing strongly, share valuations look high relative to other regions.  Nevertheless, US stocks are likely to be supported at the start of the year by the prospect of tax cuts.

Global equities fund manager Richard Saldanha likes financial stocks “given signs that incoming Federal Reserve chair Jerome Powell favours lighter-touch regulation of the sector”. This will potentially enable lenders to return more capital to shareholders via dividends and share buybacks.

On the other hand, sectors such as telecoms and retail remain challenged, Saldanha argues. And if interest rates were to rise faster than expected, highly-levered companies, especially in the small-cap sector, could be vulnerable.

The outlook for UK equities is clouded by the uncertain political climate and economic outlook, although opportunities remain on a selective basis. UK equities fund manager Trevor Green believes shares in the oil majors look attractive given the extent to which balance sheets have been repaired.

“With scrip dividends being converted back to cash dividends, the shares offer attractive yields. The oil price has rallied strongly since the summer and the share prices have materially lagged this move which gives investors an opportunity,” Green says.

He adds the UK has a few world-leading technology companies of varying sizes and some continue to look attractive long-term investments. When investing in consumer-facing businesses key attributes to look out for remain pricing power, growing franchises and an ability to defend gross margins, Green says.

References

Bloomberg, Morgan Stanley

Bloomberg, Aviva Investors’ estimates

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