Clouds forming over top
fund managers' sunny investment calls
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[July 21, 2017]
By Saikat Chatterjee and Kit Rees
LONDON (Reuters) - Stock prices climbing
ever higher as interest rates and volatility plumb rock bottom: for some
of the world's top asset managers, the investment outlook is as good as
it gets.
But look closer and clouds are forming that may put a dampener on this
sunny outlook. Investors should beware a rise in bond yields, a downturn
in economic data or a policy misstep in a large emerging market.
As the big money managers outline their recommendations for the rest of
2017, several have highlighted stocks and local currency emerging market
debt as likely winners.
The reasons aren't difficult to find.
A collapse in market volatility to record lows across currencies, fixed
income and equities means carry trade strategies, in which investors
borrow in a low-yielding currency to invest in a higher-yielding one,
have proven very rewarding.
The JPMorgan emerging market currency index is up more than 8.5 percent
this year, on track for its best yearly performance since 2010,
according to Thomson Reuters data.
A structural decline in inflation despite years of monetary stimulus
pursued by the world's biggest central banks has also meant that holding
cash or government bonds would actually leach money from portfolios.
Strategists at Bank of America Merrill Lynch estimate inflation is
rising in only 11 percent of developed markets compared with 72 percent
in February.
Small wonder that some investors believe these may be the best
conditions to buy equities as the biggest industrialized economies are
enjoying low but persistent growth, near full-employment and declining
inflation.
EARNINGS
A favorite chart with investment houses is the growing premium offered
by earnings yields over bond yields. At a chunky 6 percent, it suggests
investors would do well to buy stocks.
With earnings recovering and interest rates at record lows, Blackrock
strategists say they see "less reason" to expect equity valuation
metrics to fall back to historical means in such a world.
But portfolio managers such as Julian Chillingworth, CIO of Rathbone
Unit Trust Management, say substantial flows into European stocks from
exchange-traded funds and passive investors have pushed valuations to a
point where they are beginning to look a bit stretched.
"We feel that we’ve seen some very good economic data, but wonder
whether or not we may be close to a peak in this series of economic data
and so consequently we could see the economy not dipping dramatically,
but rolling over," he said.
Deutsche Bank equity strategists say the recent surge in European
purchasing manager indexes (PMIs) is not supported by lending surveys or
other data, suggesting economic momentum may weaken in the coming months
and weigh on equities.
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Traders work on the floor of the New York Stock Exchange (NYSE) in
New York, U.S., July 19, 2017. REUTERS/Brendan McDermid /File Photo
Fading economic momentum combined with rising bond yields would be the worst
possible combination for equities as it could squeeze that gap between stock and
bond yields.
German 10-year bond yields have doubled to more than 53 basis points in the last
month and may rise further if the European Central Bank does more to lay the
ground for the withdrawal of its policy stimulus.
POCKETS OF EXUBERANCE
Whatever the reason for their caution, investors are buying downside protection
in markets even as global stock markets scale record highs.
An analysis of more than 400 global equity and European active fund holdings by
Barclays strategists indicates conviction levels among fund managers are low and
cash levels high relative to historical averages, indicating some scepticism
about the sustainability of the market rally.
And portfolio managers at Wells Fargo Asset Managers pointed to a gap between
the record low in the CBOE's VIX "fear gauge" of implied volatility in the S&P
500 U.S. stocks index and its SKEW index, which indicates what investors are
paying to protect themselves against the risk of a big sell-off.
"Even though implied volatility is very low, the VIX skew on the implied
probability of a large move down in equity prices is historically quite high –
which shows market less ‘complacent’ than you may think," they said.
But pockets of unabashed exuberance exist.
For example, 12-month price-to-earnings multiples in India are above 18 times,
more than one standard deviation over their long-term median, indicating markets
may be frothy and vulnerable if the central bank misreads inflation data and
cuts interest rates aggressively, potentially fuelling a bubble.
Some parts of the global credit markets remain richly valued: a JPMorgan index
of global emerging market debt trading near its lowest levels on record while
Deutsche Bank strategists say downside protection on German stocks are at record
lows.
"Investors have already made double digit returns on their portfolios this year
and now is a good time to take some money off the table rather than add
positions into a potentially volatile period," said a strategist at an Asian
private bank in Hong Kong.
(This version of the story was refiled to add dropped letters in first
paragraph)
(Reporting by Saikat Chatterjee and Kit Rees; Additional reporting by Vikram
Subhedar Editing by Jeremy Gaunt.)
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