By Mike Coop, chief investment officer of EMEA at Morningstar Wealth
After another tech driven rally, can investors still find opportunities that are not fully priced? It is getting more challenging to identify undervalued equity markets after these surges in prices.
Japan is one stockmarket that has become more fashionable for the first time in decades. Our research back in 2013 flagged slow-burn structural changes, namely the so called third arrow of Shinzo Abe’s economic plan.
These micro-economic reforms targeted higher economic growth by incentivising the private sector to become more productive. Changes in corporate governance have led to a rising tide of higher profit margins, increasing payouts to shareholders and a unique structural dynamic.
Another attraction is the Japanese yen, which is at dirt cheap levels. That leave upside for currency gains and the potential for these to be large in the event of adverse scenarios. We retain higher than usual exposures in portfolios, while taking profits following the extensive rally and pricing in of improving fundamentals.
At the other end of the popularity spectrum we have UK equities, which have been seemingly abandoned by local investors, while global private investors flock to a melange of distressed sectors like real estate and in-vogue investments like AI themed plays.
For two decades, defined benefit UK pension funds have been heavy sellers as they transitioned from equity-heavy and UK biased portfolios to more bond-heavy and internationally biased portfolios.
UK retail investors also traded UK for international assets, reducing their UK equity exposure a lot. Of course, the UK has not been the only market seeing money flow to the US.
The structural unwind of British bias to UK shares has been a major headwind, depressing valuation levels. From here there is less scope for all UK shares to be impacted by the exodus of capital.
Indeed, there is little connection between dominant British listed firms and the UK because they are multinationals active across global financial services, healthcare, consumer staples, materials and energy. At current prices they rank well versus global comparables, hence we continue to invest more than usual in the UK.
See also: Downing’s Paget: Flock towards global ‘titans’ will be seen as ‘collective hysteria’
On a slightly different angle, we view defensive stocks such as utilities, healthcare and consumer staples as attractive investment opportunities.
The benefit we see here is two-fold – they offer a valuation opportunity as well as diversification advantages. Specifically, these sectors tend to provide consistent dividends and stable earnings, which are not linked to the health of the wider economy, and as such, can provide protection in the event of difficult market conditions.
In addition to their defensive nature and diversification benefits, utilities saw a significant improvement in valuations in the 12 months prior to October 2023 as bond yields rose and the discount rate – traditionally used to value listed infrastructure – rose.
We took this as an opportunity to introduce exposure within the portfolios, which also offers differentiated diversification benefits compared to healthcare and consumer staples. Just this month we have further increased exposure to this sector as weakness in performance relative to other sectors continued into 2024, together with a more positive outlook on expected returns going forward.
Having such positions within portfolios is important to ensure robustness and the ability to withstand adverse market movements.
Just as IT companies carried over their outperformance from 2023 to 2024, so did riskier bonds. Growth, inflation and oil prices turned out higher than expected, triggering an unwind of optimistic expectations for large and rapid falls in interest rates this year.
This impacted longer-dated bonds which are typically dominated by government borrowings. High yield and emerging market debt outperformed and we have been trimming exposures as the extra yield for their risks comes down.
By comparison, the yields available on safer debt mean they are well placed to perform their role of a portfolio stabiliser in crisis periods and to generate returns superior to cash and inflation.
The story of 2024 is one of gyrating markets and rapid swings in sentiment. Investors should hold a diverse mix of assets that can provide support in a variety of market and economic conditions, with the overriding objective of helping clients achieve their long-term financial goals.
See also: Does the ‘magnificent seven’ tech wobble signal a turning point?
