The stand-out performer in the global risk markets since the March 2009 trough has been the US equity market, but how much longer can this go on for? Matt Sherwood, Perpetual’s Head of Investment Market Research examines this and finds that the US outperformance has been driven by rising valuations and superior earnings growth (even though the current US economic recovery remains the weakest in history). However, both of these drivers are likely to prove to be more difficult to sustain in the period ahead with US rates moving higher and with profit margins already at cyclical peaks. A normalisation of US interest rates is likely to underpin a normalisation of US share valuations and, as such, global investors may need to look at portfolio weights and the ‘asset quality’ of their portfolio. Things are changing and the global outlook is looking better, but we are not going back to pre-2007 market conditions, so caution is still warranted.
Key takeouts:
* In 2014 most global risk markets have struggled to maintain their momentum of recent years as heightened earnings expectations are tempered by a sub-trend global recovery and higher global interest rates. The battle between stretched valuations and a gradually improving global economy is already well advanced with no clear winner, but tightening cycles typically curtail US valuation expansions which means that share price trends are increasingly driven by earnings growth. However, with profit margins already at cyclical peaks, it is hard to see how US earnings can grow much more than nominal US GDP (+5%pa) which is likely to limit future returns. Stock selection here remains the key.
* Domestic market analysts may have to revisit their 2014 forecasts in the coming months as the Australian economic rebound has been stronger than initially thought. While a slightly stronger domestic economy will be good for the upcoming Federal Budget, it comes with a cost in that the Australian dollar has appreciated (impinging growth for exporters and import-competing firms) and markets are now expecting higher domestic interest rates in 2015. In this environment, investors need to remain cautious as a lot of good news has been factored into market prices and a lot has to go right for those prices to be justified.
For the full article click here: Perpetual Perspective – April 2014