Global equities and Trump
What Donald Trump, rising interest rates and more will mean for global equities amid a growing investor appetite.
The past year in global equities has seen a surprising turn of events.
The lead up to 2016 was filled with pessimistic views from analysts, who believed much of the volatility from 2015 would creep into the new year.
And it did – at least for the first half of 2016. According to research from Colonial First State Global Asset Management, investor confidence in equities fell by a total of 29 per cent in the months between January and May last year.
But as 2017 begins to unfold, this sentiment begins to change, which is being driven by lukewarm returns from bond markets as well as increasing concentration risk in Australian equities, says Ben Smoker, chief executive for Saxo Capital Markets.
“Concentration risk stemming from widely-recognised overweight holding of Australian equites in the average investor portfolio is driving an increased appetite for global equities beyond our shores,” he says.
“Other factors driving interest are around negative headwinds sapping demand from alternative asset classes, such as continuing low yields in fixed income instruments, as well as the burgeoning property market, where prices continue to surpass record highs.”
Despite a growing interest from investors, not everyone agrees that now is a good time to invest in all global equity sectors.
This year is deemed to be unpredictable, with many expecting an impact from rising interest rates and US President Donald Trump’s proposed policies.
However, it is because of these influences that others believe the global equities market is on the verge of a rebound.
As PM Capital chief investment officer Paul Moore puts it, “The Trump election has marked the end of the post-GFC era.”
“People’s focus is now going to be on how strong growth will be, how much inflation will rise, how much interest rates will rise. While at the start of the year it was all about the opposite,” he says.
“It’s amazing how much has changed over the past year.”
According to Gaudi Schneider, senior quantitative strategist for digital wealth management provider Quantifeed, the opportunities in global equities currently lie in at the sector level.
He says 2016 has seen “surprising political change” in many parts of the world and global monetary policy is about to enter a new regime, which is largely supported by an increasingly healthy US economy.
“These changes affect individual sectors and companies in a different fashion. As a consequence, we have seen pronounced sector-rotation in the last weeks for 2016,” he says.
“Chances are that equity risk and opportunity continue to become more sector and country-specific than in the past. An investment approach focused on sectors and emerging trends might be advantageous in this environment.”
PM Capital’s Mr Moore would agree, and add that banking, housing and transport are his preferred sectors.
“Those companies that can either grow their earnings, or provide an above normal yield, are the companies that you want to focus on,” he says.
“We still think over the next 18 months there will be a sweet spot for US domestic banks driven by higher earnings revisions. If Trump’s corporate tax reduction reforms do get passed, we think there is also a 20 to 30 per cent upside there.”
Saxo, on the other hand, will be looking at China.
Mr Smoker says his firm has a “slightly controversial bullish call on China’s stock market seeing private consumption driving growth higher and generating solid returns from the Shanghai Composite index for 2017”.
Morningstar portfolio manager Bianca Rose says she currently favours emerging markets over developed markets, adding that the US is “expensive”.
“We have concerns there in terms of valuations and high profit margins, but there are some select areas in the developed markets that we do like,” she says.
“This includes European energy and we also like Japan. With Japan, it’s more of a corporate government story, so we feel like the profit margin could be maintained there and valuations are reasonable.”
Olivia Engel, head of active quantitative equity for State Street Global Advisors (SSGA), believes the global equities market still needs to see some further earnings growth to justify current prices.
However, there is opportunity in stock return dispersions, she says.
“That is, the difference between the strongest and weakest performers. If the dispersion is large, then the payoff from selecting the right stocks is large,” Ms Engel says.
“This is a good environment for stock picking and active management. Over the last two years, this dispersion of monthly returns is now around 1.5 times what it was two years ago.”
The Trump effect
Donald Trump’s election victory may have been unexpected, but it is already having an impact on the global equities market, says Greg Goodsell, global equity strategist at boutique fund manager 4D Infrastructure (4D).
He says markets are much higher than they were before November, and there has been shift in which stocks are doing well.
“Ever since Trump moved in you’ve seen equity markets rally,” he says.
“The stocks that have done well are the cyclical stocks. Bank stocks have done well so far because there is a perception that [Mr Trump] will wind back bank regulation.
“On the flip side, defensive stocks haven’t done as well and, similarly, the bonds market has been sold off.”
Wingate chief investment officer Chad Padowitz would agree that the immediate reaction from Trump’s election has been positive, although unsure if it will last.
“I think it has brought a little bit of needed change. He certainly brings some level of unpredictability and some policies are seen, at least in the short term, to be pro-growth, which I think the market has been searching for,” he says.
“But I’m not sure how long lasting that is. We certainly wouldn’t, and don’t, invest on those things. I think in the weeks and months to come, any Trump effect will die down substantially.”
That’s not what PM Capital’s Mr Moore believes. He thinks people have “totally misjudged” what has subsequently transpired from the Trump election.
“Trump wants to get rid of all disincentives for US companies to invest in America and get rid of all of the incentives to invest offshore,” Mr Moore says.
“Businesses have become so frustrated with the stagnation, and the fact that government has been all talk and no action, whereas now, they’ve got some pretty simple principles that are all based on infrastructure spending and border protection.”
He adds: “Interestingly, that frustration with stagnation and the lack of dealing with tax and regulatory issues is around the whole global economy. So Trump being elected and the implementation of his platform will lead to others following.
“Other jurisdictions will therefore have more confidence to take on [growth] programs.”
SSGA’s Ms Engel would note, however, that while there is a degree of optimism attached to Trump’s administration, there is still risk as well.
“Without a crystal ball, the best we can do right now is focus on finding companies for the portfolio that exhibit sustainable earnings growth, strong cashflow, a positive outlook, are high quality and can be bought at a reasonable price,” she says.
Rising interest rates
There is talk around rising interest rates in many parts the world, but perhaps the most anticipated hike is the US federal government’s.
SSGA’s Ms Engel says interest rates usually rise when there is recovery in economic growth, upward pressure on wages and low unemployment.
She says this is positive for equities in general.
“It will be risk for equities if inflation starts to get too strong and interest rates have to rise too fast,” she says.
“A steady moderation of interest rates to more normal levels will signal strength in the economy.”
Quantifeed’s Mr Schneider said one of the general expectations from rising interest rates is that banks will profit, while equities held largely for income generation will come under pressure from fixed income alternatives.
“Some sectors are less sensitive to interest rates and thrive on cyclical growth, like consumer stocks, or secular growth, like some technology companies,” he says.
Saxo’s Mr Smoker notes, however, that there was an “aggressive sell-off” in January 2016 following the US rates increase in December 2015.
Still, he does not expect the same reaction this year.
“This time around, there seems to be greater comfort and optimism around sustained growth in the world’s largest economy, despite the prospect of further rate increases into 2017,” Mr Smoker says.
The prospect of rising interest rates is also prompting investors to sell out of bonds and into equities, says 4D’s Mr Goodsell.
“In fact, you’re seeing a movement out of the bond market and into the equity market because there is this perception that you’re going to see a period of stronger growth and that’s going to help equities perform,” he says.
Rising interest rates is not the only factor pushing investors into global equities.
Quantifeed’s Mr Schneider says Australian investors are increasingly becoming aware of the diversification and opportunities offered by offshore stocks.
“While the Australian market offers good coverage of the materials sector and domestic financials, the technology sector – to give an example – only represents 1.2 per cent of the ASX 200,” he says.
“Investors looking to diversify into technology, or even into global trends like the rise of social media, might have to look abroad for suitable opportunities.”
The best vehicles for exposure
When it comes to which vehicle is best to gain global equity exposure, Saxo’s Mr Smoker says it all comes down to the understanding of the instrument.
“Direct investing in individual international equities has increased over the past 12 months,” he says.
“At Saxo, we have seen a gradual trend of investors seeking to own shares outright in household names, such as Apple, Google, Microsoft, Johnson & Johnson, HSBC, Deutsche Bank, etc.
“The ETF space is growing exponentially and remains a good low-cost way to invest in global equities for the time-poor investor.”
Quantifeed’s Mr Schneider believes separately managed accounts are good, as the investor is not impacted by other investors leaving and realising capital gains.
“The only tax realisation occurs when you sell out of your own holding of the underlying securities,” he says.
“This is important for global assets, as some unhedged investors may seek to realise gains on the back of combined asset and foreign exchange returns, while others may prefer to stay in the investment.”
Meanwhile, SSGA’s Ms Engel says index funds can offer diversified exposure to equities at a very low rate, while active funds can provide differentiated exposure and the benefit that they seek to outperform the indices.
“Currency exposure is an extra dimension to consider when investing offshore. Each investment vehicle should specify the currency management approach used,” she adds.
No matter the vehicle, however, 4D’s Mr Goodsell notes that global equities should be looked at as three- to five-year investments.
“What happens in the equity market tomorrow is anyone’s guess,” he says.
“You need to be investing with a medium-term time horizon in mind. I’d be very confident in saying that in five years’ time, equity markets will be higher than they are today.”
PM Capital’s Mr Moore would agree.
“When you’re investing in equities, it’s not a short-term commitment,” he says.
“If you want absolute certainty over a time period, you have to have cash or bonds. But provided you’re willing to invest over the longer term, our belief is that the best risk adjust return will come from equities.”
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