Peter Carvill finds where the opportunities lie for global equities within volatile markets

In 2009, according to World Bank statistics, the overall GDP growth of seven of the world’s largest economies showed a steep reduction. Of those economies, five – the European Union, Brazil, Russia, the US and Japan – experienced a sharp contraction in GDP; one – China – continued to grow, despite GDP growth slowing; and the remainder – India – saw a surge, with its GDP growth rate increasing from 4.9 per cent to 9.1 per cent. 2010 saw minor recoveries for all those economies.

While the World Bank does not yet have statistics available for 2011, it can be surmised that the events of last year are little comfort. The eurozone’s ongoing crisis, which has exerted a gravitational pull on the world’s myriad economies, dominated the news. This year began negatively for the eurozone, with Standard & Poor’s downgrading the credit rating of nine countries within the region. In Riding Out the Storm: Global Equities in 2012, HSBC global head of equity strategy Garry Evans says that another credit crunch is possible in 2012, particularly in Europe.

The outlook then for 2012 is largely a negative one. Writing in Riding Out the Storm, Evans says: “Our economists are forecasting just 1.7 per cent real consumption growth in 2012. Meanwhile, growth in the eurozone, even in core economies such as Germany and France, has started to surprise on the downside and, in our economists’ view, more peripheral economies such as Italy and Spain are already in recession. And there are signs China’s growth is starting to slow a little too.”

Further on, he adds: “HSBC continues to forecast 8.6 per cent GDP growth in China in 2012. For now, the consensus among economists remains cautious, but not bleak. They see 1.9 per cent growth in the US in 2012 after 1.7 per cent in 2011, but just 0.6 per cent in the eurozone after 2011’s 1.6 per cent.”

Vontobel senior portfolio adviser Sudhir Roc-Sennett is sanguine about the lessons of 2011. Speaking to Pensions Age, he says, “Last year was about what to avoid as much as what to invest in. There were unusually powerful, systemic problems, most importantly being the European banking system, which is something that, for many reasons, is somewhat toxic. There is little doubt that a large chunk of the market would be effectively bankrupt if not for the European Central Bank.”

This market turmoil is having a negative effect. Invesco Perpetual product director for global equities Luke Stellini says that in terms of asset allocation models, the regional asset class of European equities is the most consensually underweight. He cites anecdotal evidence in support. “We did one of the long-run charts that we put together for European equities, and which look at the direct ownership by European insurance companies and pension funds of global equities. The figure was around four to five per cent, having been 18 per cent around eight to 10 years ago. And when we meet with the likes of an Allianz or an ING, they tell us that their exposure to these is in low single-digit territory.”

Those investments are heading elsewhere. Stellini adds: “In the context of money staying within equities, I would have thought that the obvious flow would have been out of the perceived levels of higher-risk that you get in Europe in favour of a more diversified global portfolio.”

Within the US, Stellini says the picture is somewhat different. “If you look at the relative values measure, the US is looking pretty stretched. If you look at earnings momentum compared to Europe, it’s a different picture. In Europe, you are seeing a race to the bottom. We haven’t seen anything like that in the US so it’s looking relatively expensive compared to Europe.”

The global equities market for emerging markets appears to be going from strength-to-strength. However, the eurozone’s economy and the instability of the US’s are likely to have an effect. Hermes institutional portfolio manager John Chisholm says: “Five years ago there was a lot of talk about emerging markets decoupling and we don’t hear much about that now. The reality is that most emerging markets still derive roughly 25-30 per cent of their GDP from exports of goods and services. Some emerging markets have improved the balance of their economy and they are seen as higher quality given their relatively stronger fiscal and monetary balances relative to many developed markets, but decoupling remains a long ways off. With the US and Europe accounting for enormous portions of the global economy and emerging markets dependency on export growth, they cannot realistically outperform without greater stability in Europe and the US. Yes, the acceleration of intra-emerging trade in recent years helps mitigate those impacts, but it’s not big enough to overcome it. The size of the domestic economies in many emerging markets simply isn’t big enough to overcome weakness in the US and Europe. The past 10 years in emerging markets, we have seen great performance, but it has been cyclical growth. A lot of it was driven by the leverage in the US and Europe, which is now reversing.”

There are large questions around China. Having experienced almost unprecedented growth in the last decade, the superpower’s economy is now the world’s second-largest. Many feel that its growth is unsustainable. Says Stellini: “I suppose the key one is what happens in China. Everyone is wondering about a ‘hard landing’, and it’s one of the preeminent issues in the market, excluding the eurozone and the US.”

He adds: “However, I think there is an expectation that they will manage to engineer a soft landing. We had an overnight Q4 GDP number out of China that surprised us positively with all of the right noises. They’ve been loosening policy significantly with a view to engineering that soft landing.”

As the economy rapidly shifts, so does asset allocation. The macro picture is depressing. Undoubtedly, there is tremendous external pressure on the world’s economy – ongoing government debt, a stagnant credit market and the very real possibility that countries within Europe may be declared bankrupt, perhaps precipitating an abandonment of the single currency.

“In light of this highly uncertain macro outlook,” writes Evans in Riding Out the Storm, “how should investors be positioned for 2012? In a tricky economic environment, where margins will be under pressure, we prefer companies where earnings can buck the likely trend of forecast downgrades, possibly as a result of cutting costs or restructuring. We also like companies with strong flow businesses (such as aftermarket sales) and niche businesses. In some industries, falling raw materials prices will support margins. Lean inventories and tight supply chains will also be a support against cyclical headwinds. We would avoid companies with excess exposure to peripheral Europe, those that are strongly cyclical, or where company earnings targets are too optimistic. Our preference is also for companies with strong underlying growth that is not priced in.” He adds further that growth will come from strong positioning in fast-growing emerging markets.

Evans outlines HSBC’s investment strategy for 2012: “We thus look for companies that are best positioned to deal with tight credit conditions: those with strong balance sheets, low gearing and good cash generation. We are wary of companies with weaker balance sheets or significant refinancing needs during 2012.”

For Roc-Sennett and Stellini, the issue is more granular. In any economy, they say, there are always worthwhile pockets of investment. The thing then is to recognise them. Large, global companies and industries offer the best home for investment, with Stellini singling out large pharmaceuticals and Nestle as worthwhile opportunities. Roc-Sennett points to what he calls “large, global franchises with a solid US foundation”.

The key, then, is step-by-step, day-by-day. “When we invest,” says Roc-Sennett, “it’s very much a bottom-up, stock-by-stock process. Even though we talk about the macro situation, we talk about it stock-by-stock. You can have a weak macro situation but a powerful company to invest in.”

Written by Peter Carvill, a freelance journalist

Share Story: