Excuse the clumsy analogy, but with equity managers’ having already taken their pick of the best treats on offer are valuations now looking as stretched as our post-Christmas waistlines?
One of the UK’s largest managers (in terms of AUM, of course) Invesco Perpetual’s Mark Barnett has already warned that some valuations still look elevated, where share prices do not appropriately anticipate the risk to earnings and cash flows.
As ever, he places a high price on companies which offer visibility of revenues, profits and cash-flows.
Despite the relative optimism across markets in the past couple of years, it is defensive sectors which continue to look expensive, and perhaps vulnerable to potential rate rises in the UK and US.
Valuation talk overdone?
Still, on the latter market, Guy Foster, Brewin Dolphin’s group head of research, believes talk of valuation excess is overdone.
“US equities are fairly priced, and the attractions relative to other asset classes remain highly compelling,” he says.
“Of course the US economic story is now well understood, but in the face of an increasingly benign inflationary outlook, we expect the Federal Reserve to remain highly accommodative. Such a stance could well drive US equities into a sustained period of over-valuation.”
Interest rates can of course play part in determine valuations for risk assets such as equities. Higher rates can drive earnings and dividend yields up, and valuations down, while also impacting investor confidence and risk appetite.
The big consensus
If there is one over-riding consensus for 2015 it is that equity volatility will rise across markets, perhaps opening the door for more attractive valuations for stock pickers.
In BlackRock’s outlook, chief investment strategists Russ Koesterich, Ewen Cameron Watt and Stephen Cohen, said investors must learn from mistakes in 2014 when crowded trades were punished. This included, Japan in January and the US tech sector in March.
“Many asset class valuations are stretched, trades are crowded and volatility will likely rise,” they say.
“Investors need to have both the flexibility to take advantage of the opportunities that bouts of volatility bring and the safeguards in place to exit crowded positions when the time comes.”
The trio believe that, while fairly valued, European stocks are still cheaper than their US counterparts; “attractive in a world of relative, rather than absolute, bargains”.
“While expensive, we find selective opportunities in US equities: tech stocks look attractive for their growth potential and benefit from the reinvestment of capital.”
While equities remain the most attractive class overall, it arguably means valuations mean less to investors keen to avoid fixed income. For Neptune’s head of UK equities, Mark Martin, although absolute valuations have increased markedly over recent years, parts of the UK equity market remain attractive relative to many other asset classes.
“Ongoing de-leveraging continues to be a headwind for Western economies, and companies with structural growth opportunities are likely to be increasingly sought out,” he says.
His focus is on companies that he believes are set to benefit from structural growth trends or a significant level of internal self-help or management change.
“In the absence of organic growth opportunities, well-funded companies may look to return excess cash to shareholders, or engage in M&A to grow sales and profits,” he adds.
“Pfizer’s approach for AstraZeneca, as well as several lower profile deals, bears witness to the renewed corporate appetite for M&A.”
