Its a mantra weve all become accustomed to: equity valuations are not cheap, but nor are they excessively expensive. But are we just setting ourselves up for a fall?
Fears of a correction are nothing new with markets having been on a (relatively) robust upward path for some time now, but it is only now that the wealth management community are talking more openly about preparing for a downturn.
Could cash reign again? While suggesting that recent selling in equity and credit markets would appear to be “a dose of reality to over-optimistic expectations and extended positions in risk assets,” PSigma Investment Management made its move last month.
Says CIO Tom Becket: “Our portfolios were de-risked in July, as we booked profits in Japanese and European equities, taking our cash weightings toward their highest possible allocations and developed world equities underweight, for the first time in six years.”
At the risk of over-extending
Kleinwort Benson is another high-profile wealth manager which has been reducing risk in portfolios on a rise in market valuations and increased investor complacency. CIO Mouhammed Choukeir says he would reduce this further if and when he sees momentum turning negative or valuations becoming overly extended.
However, from analysis of previous bull markets, he says global equity valuations are still not as stretched as previous market peaks.
He adds: “Higher valuations lead to lower returns over time. It is as simple as that, and currently, valuations are near long-term averages rather than at extremes. For example, the price to book of global equities is 2.1x (versus 2.0x long-term average). At its most recent peaks in 2000 and 2007, the price to book ratio reached 3.3x and 2.7x respectively.”
As revealed in a Pridham Report earlier this week, it is large-scale multinational fund groups that continue to dominate in terms of retail net inflows. With the exception of outlier Woodford Investment Management, the likes of BlackRock, Henderson and Standard Life all pride themselves on their depth of offering across the asset class spectrum.
It is not necessarily the case that vast sums of retail money is being thrown into developed market equities, with property and absolute return also gaining in popularity.
This time is not different
In a post-credit crisis world, the retail investor is more aware of the risks than in 1987, 2000 or 2008 and a ‘this time is different’ mentality no longer cuts it as a justification for higher valuations.
Adds Choukeir: “In the 1920s, things were ‘different’ because a new age of mass produced automobiles (and other machines) would ‘transform’ productivity. In the 1990s, it was ‘different’ because the internet would transform communication and commerce. In the 2000s, policymakers had supposedly ‘tamed’ business cycles. Though many of these innovations did truly change the way we live, stocks became overvalued as prices lost track of the fundamentals.”
Today, he suggests the ‘this time is different’ maxim is being applied in a different context, with unprecedented central bank policy – namely quantitative easing – cited as a justification for higher valuations.
Throwing money at the problem has proven to be a success (to a point) and, yes, things may be different than before, but here’s another mantra: ‘what goes up….’