Fidelity looking for the turning point on equities
Equities are expected to continue being priced at historical lows in the immediate near term, but the triggers for a re-rating are approaching, according to views from Fidelity Worldwide Investment’s Global CIO Equities, Dominic Rossi.
Speaking in London today, he said that his own company continued to see outflows from equity into fixed income, as selectors still had a preference for bonds in the current environment.
And although equities as an asset class were likely to remain cheap for some time, investors still had to think about the factors that could precipitate a rapid turnaround in valuations.
The key challenge is volatility. “It remains a volatile asset class,” Rossi (pictured) said. Clients are looking for lower volatility strategies, which is why they demand a high premium: only then will they be attracted to the asset.
Earnings growth and/or a re-rating of the asset class would propel prices higher. However, there is still a low probability that earnings can improve from here on. Many companies are already highly profitable – indeed “pofitability growth in the next 12 months will face some headwinds,” Rossi added.
Earnings growth troubles are not only a problem in Europe, but there is some concern over how US companies will also manage to maintain the earnings surprises that have marked out the past six quarters, Rossi said.
If it is not earnings growth that will turn around equity prices, then it will require a reduction in volatility, down to a level of about 15% – and remain so – for a re-ratings cycle to take hold.
Rossi said there were three factors that are key to any reduction in volatility: the situation in Europe, the situation in the US and the situation in the commodities market.
Europe faces three crises all bound up together; the banking crisis, the sovereign debt crisis, and the question of competitiveness.
Banks have been taking steps to de-leverage and recapitalise, but the interbank lending market still looks weak and even steps to inject capital directly into Spanish banks leaves a considerable amount of work to do.
Sovereign debt is still suffering the overhang of excessively high national debt/GDP ratios. And the impact if anything is likely to get worse over the coming year, as, for example, France starts to properly implement the fiscal measures required. Even positive stories, such is Italy generating surpluses, have to run for much longer before they start to have a real impact on the current picture.
Meanwhile, Europe’s peripheral countries face the question of how to restore competitiveness.
The key challenge from the US is the so-called ‘fiscal cliff’ – the point at which current tax breaks automatically expire and higher taxes start to impact. There is only a short window of opportunity between November-December for the administrative and legislative branches of government to agree new rules. Otherwise there is a risk – already calculated by the Congressional Budget Office – that the country will be tipped into recession early next year.