Six things investors should mind
Stephanie Flanders, Chief Market Strategist for Europe, JP Morgan Asset Management:
On the gloom about Europe
The eurozone is approaching a critical period – both economically and politically. Weakening activity and the continued low level of inflation has heightened investors’ expectations that the European Central bank will act to support growth.
This has already helped push down the value of the Euro, which should help corporate earnings in the next few months.
But continued slow growth and very low inflation is putting renewed pressure on government balance sheets, particularly in countries such as Italy, and lending growth in these economies is still weak. We need to see improvement on all these fronts in the coming months to feel confident in the strength of Europe’s recovery.
The ECB has always said it couldn’t fix the eurozone on its own – the difference now it that investors have finally decided to believe it.
There is now so much pessimism around, there is scope for a change in sentiment around the turn of the year as the weakening of the Euro starts to feed through to corporate earnings and the review of European bank balance sheets lifts the question mark hanging over the financial system – but governments need to do their bit to make that happen.
There is not much sign of that as long as Germany, France and Italy are bickering about their budget plans.
On the investment environment
Diversification as probably never been more important for investors, as we move into what may well turn out to be a volatile time in global markets. Higher interest rates have not stood in the way of rising equity markets in the past. But nor have interest rates been so low, for long. No-one knows exactly how the next year will play out for investors, but the best response for investors is much more tried and tested – a well diversified portfolio.
The main developed markets are no longer cheap but they look reasonably priced to us, particularly when compared with core fixed income assets. In the US, we see diminishing scope for multiple expansion or rising profit margins to contribute to investor returns in the next year or two, but growth in corporate earnings should continue to deliver moderate returns.
On the search for income
Diversification is a also a key theme for investors in the search for income, because the search is not getting any easier. With dividend yields in major equity markets still at attractive levels, sourcing income through equities is a way to enhance and smooth returns in this low yield environment.
Indeed, in the UK, it is striking that the benchmark corporate bond yield is now extremely close to the dividend yield for the FTSE 100. However, investors should be mindful of valuations, as some high-yielding sectors and stocks have become stretched. This is another area where valuations in Emerging Markets look more compelling.
On asset allocation
The bottom line is that this is still a world that rewards risk takers: an overweight in equities and other risk assets makes sense as long as all of the main central banks are looking for more growth and higher inflation than the world economy seems able to deliver.
On the dollar
Every conversation I have had with senior fund managers and economists over the past few days has been dominated by talk of the strong dollar. The US is becoming more self-sufficient on the trade front at a very inconvenient time for the rest of the world.
With so many countries looking abroad for demand to drive their recoveries, it’s hard to avoid the conclusion that the dollar is going to keep going up against most major currencies. Periods of dollar strength have often been bumpy ones in international markets.