Divergence and volatility key themes for investors, says JP Morgan AM
Different rates of economic recovery will affect central bank policy resulting in divergence that will effect volatility in coming months, according to JP Morgan Asset Management chief market strategist UK and Europe Stephanie Flanders.
Commenting on the manager’s latest Guide to the Markets for the fourth quarter this year, she said the volatility would also be spurred by relative valuations of assets.
“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.”
“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.”
The crux of the argument, then, rests on central banks continuing to stimulate rather than pull back on their measures.
Flanders said that investors might be expecting a change, such as the end of asset purchasing by the US Federal Reserve and rising interest rates. But, even there the change is likely to be slower than many expect: there is considerable range to the forecasts the Fed has provided for the coming few years, and meanwhile any decisions it does make will be heavily “data dependent”, suggesting that it will want to be absolutely sure of the case for hiking rates.
Delving further into the key challenges facing investors, Flanders noted that the eurozone is looking particularly vulnerable to shocks.
“The next few months could be critical to the long term health of eurozone recovery,” she said.
David Stubbs, global market strategist, added that the relative strength of the euro was of concern to those looking to fixed income instruments, particularly sovereign debt.
“Investors who are focused on preserving their capital can protect themselves from the direct impact of higher US yields with an overweight in European assets. Though European sovereign bonds are expensive by any historical standard, weaker growth and inflation in the eurozone, and the prospects for further ECB action, could well push bond prices even higher. But investors choosing this path should be mindful of the prospects for continued weakening of the euro against most major currencies.”
Overall, however, JP Morgan AM’s central projection is that there is not going to be another global recession in the near future.
In contrast to Europe, there are particular structural and cyclical arguments in favour of emerging markets, argued Richard Titherington, CIO and head of the Emerging Markets Equity Team.
“Broadly, emerging markets can be split into two groups: commodity importers and commodity exporters, where commodity importers are typically exporters of manufactured products. For example, compare China and India to Russia and Brazil. The former two are commodity importers, with more manufacturing or services-based economies, while the latter two rely heavily on natural resources for their economic output. Manufacturers have historically benefitted from developed market demand faster than commodity exporters.”
The key risk to emerging market investors now is the rising strength of the dollar, Titherington said.
This lowers the prices commodity exporters can achieve. But it also signals interest rates in the US are on the up, which tends to attract capital out of emerging markets to the US. And it often does not take a substantial amount of selling of a local currency to have a significant effect on currency rates.
Investors are also lacking visible triggers such as M&A activity that could act to boost the value of local equities. For example, despite the fall in share prices in Moscow, it is unlikely that Exxon would bid for Gazprom – the politics would be against it. Also, in many emerging markets there are still family connections that act as hurdles to M&A – such as the family behind Samsung in South Korea – in addition to larger companies being seen as national champions that should not be sold to foreigners.
However, Titherington noted that whereas investors in markets such as Brazil and Russia are concerned today about the pace of reform, it tends to be the case that when economies are in trouble, they result in reform.
And for many emerging markets, the sensitivity to an upturn in developed market growth means that they could benefit from continued recovery. Investors should not be too concerned with a slowdown in the growth rate of China to 6-7%. Historically this has happened in the past; growth will be cyclical.
Currently, Titherington said he is interested in the places people “hate”, markets that are cheap relative to their own history.
Investors also need to keep in mind earnings per share and dividends paid out in emerging markets. He said that this is often forgotten by emerging market investors, but dividends can provide access to compounded growth rates.