Uncertainty and opportunity reflect cheap equity

George Renouf restates his commitment to equities despite global equities suffering a year-long decline with more volatility to come.

Uncertainty and opportunity reflect cheap equity


This was how I closed my submission of 20 March.

In my defence, I did also mention that there might be a “bit” of volatility! Global equities are off by around 5% over the past three months which puts them into negative territory over the past year and company fundamentals have in many cases been completely overlooked.

A short-term move of this magnitude causes us all to question some of our assumptions around short-term risks and long-term returns as well as the fundamental valuations place of stocks, sectors and markets. It also causes me to stress test what impact further volatility will have on my portfolio and how alternative strategies or asset classes might provide a more balanced approach to the current and future environment.

Stock market moves

Looking within stock markets we have recently seen a rotational shift from the cyclically sensitive sectors into the more defensive ones but over the year performance has been very mixed with both sectors seeing some of the best and worst performers.

If we look on a global sector basis the best performers year to date have been technology and consumer goods up 7.8% and 4.5% respectively with the biggest losers being oil & gas and utilities down 5.8% and 4.2% respectively.

With this mixed performance and weaker economic data it is not difficult to see why investors are unwilling to make any pro-cyclical bets at the moment especially given that earnings momentum continues to slide.

Then there is the small matter of Europe to add into the mix.

The more this year progresses the more it resembles 2011. Last June the consensus was that we were entering a “soft patch” and that growth numbers would pick up in the second half of the year. They did so in the US and markets responded accordingly, but that was after Europe came under the spotlight in August and markets fell by some 15%.

Roll the calendar forward 12 months and we see economic data softer and the spotlight once again shining even brighter on Europe and markets are off 5%.

So, are the same issues valid this year to last, are we on the brink of slipping back into recession and further stock market falls and can the euro survive or will Germany and the G20 ride to the rescue just in time to save the European dream?

An end in sight?

Frankly I don’t know. And I don’t think anyone who claims to know knows. We can speculate as to what may happen on the back of certain outcomes but we cannot accurately predict what might happen in Europe or the world economy over the next three months, never mind the next three years.

The most recent statements from world leaders suggest that a comprehensive plan to deal with the eurozone debt crisis is closer; they said that last year as well. Clearly this would be greatly welcomed but with so many interested parties with conflicting agendas, a mutually agreeable solution may be more difficult to implement than many assume and any plan that cannot deliver economic expansion, long-term debt reductions and fiscal consolidation across the member states, will be treated with further scepticism by investors.

Further kicking of the can down the road is not sustainable, fundamental reforms are required. Whatever is proposed cannot be delivered overnight and that seems to be what the market wants.

Economic growth is fundamental to the solution, not just for Europe, and delivering this in tandem with cutting deficits is not easily achieved. Fiscal unification has to be part of the solution and may be the crux; integration or disintegration may be prophetic!

As we have seen recently, the German politicians have shied away from the prospect of issuing eurozone government bonds. There is still no constitutional provision for full fiscal union or de-unification but I hope that plans are being worked on with some urgency. The stakes are very high and not just for Europe or Greece so we must urge our politicians to act decisively with cohesion and a common vision.   

Equity value

I said in March that equity valuations looked attractive but we would experience volatility in the short term; well I have been proved correct on the volatility front as the market is 5% lower, so equities must be even better value!

On a six-month view I cannot have certainty on this, and as we have seen in the past, that sort of timeframe leaves too much to chance.
2011 was a rollercoaster of a year which had almost every type of difficultly investors have to cope with; so far 2012 has seen many similarities and in that sort of environment, it is so difficult to keep one’s head when all around you are losing theirs which requires discipline, rigour and confidence in the original investment case.

To help with that it is important to emphasise the basis of the argument for equity investment. Over the past fifty years, UK equities have outperformed gilts and cash; 5.3% versus 3.1% and 1.6% on a real annualised return basis (US numbers are similar).

Over a shorter timeframe it is also worth noting, particularly given that the FTSE 100 is at the same nominal value as it was in 1998, 2001, 2005 and 2009 that the investment trust global growth sector has returned 109% on a total shareholder return basis over that period, showing that active managers, even in a flat market, can produce meaningful investment returns for shareholders. Admittedly much of this return will have come from dividends but that is part of the fundamental reason for investing in quality companies with strong cash flow and ROE.

This has to be the basis for the rigorous fundamental analysis and the strategic frameworks we maintain to assist with the investment process. At the heart of it should lie such a thorough understanding of the drivers of each business that each item of news merely affirms the sensitivity analysis that has been already completed.

In the end, as long-term investors, uncertainty is seen as an opportunity as it provides the chance to invest in companies at attractive valuations.


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