Yet markets still seem content to grind higher on incrementally better economic data and improving sentiment as underinvestment in equities since 2007 reverses.
History repeating itself?
Country and sector performance in global equity markets may suggest that doubts about the underpinnings of this equity rally persist. Year-to-date, defensive sectors like healthcare (10.5%) have outpaced cyclical sectors such as energy (3.9%) and materials (-1.8%). At the regional level, developed markets have outperformed emerging nations’ stocks by around 6.5%. Asian emerging markets have been a notable exception, supporting our preference for this region.
Readers with good memories may be less concerned by the extent of this year’s equity rally, given the experiences of previous years. Indeed, by this time last year, global equities had risen 8.3%, outstripping the rally year-to-date by nearly 2%.
However, in each year where global equities were up by early March (2010, 2011, 2012), global equities had pared gains by mid-year. Compared to other post-crisis years, the laggard nature of global materials stocks is unusual – materials were up 8.3% this time last year.
So what is the bottom line for investors? We do see the conditions for a sustained rally over 2013 of improving economic momentum, muted financial pressures and higher belief in the case for equities. Nevertheless, we reiterate that adding to equity risk should be a function of buying on weakness and exploiting pockets of value. Given richer valuations than the start of the year, continued strength in equities may require eventual execution on improved earnings. When earnings growth crystallises, we believe laggard cyclical sectors may begin to lead the equity pack once again.
The asset-backed argument
Following recent deliberations about the outlook for fixed income investments, asset-backed securities (ABS) will be added to the list of asset classes that could potentially be added to fixed income portfolios.
A number of issues have to be flagged in this context. First, the universe of asset-backed securities is very wide and the strategy will be to confine exposures to the higher-quality structures where losses have been lower than ordinary corporate bonds throughout the crisis.
The majority of instruments that fit these high quality, solid criteria would likely be in the UK and Dutch residential mortgage market, with automobile and credit card receivables likely to offer a high degree of stability. Of the bonds rated AAA before the crisis, the majority in these sectors are still at that rating (hence of better credit quality that the UK or French sovereign).
Second, attention will only be paid to fund-type investment vehicles that aim to offer a high degree of liquidity and transparency. We believe the focus should be on a well-diversified, high ABS portfolio, avoiding higher risk, equity-like securities.
Third, and somewhat disappointingly, current valuations are on the expensive side: all assets credit-related have performed very well over the past 15 to 18 months and high-grade ABS has been no exception. Nonetheless, it may be the case that in carefully selected areas ABS offer better value than government bonds, subject to investor suitability. The market will be monitored for such opportunities.
