Market report September 2019
Equities in global markets rose in the third quarter, but investor sentiment remained volatile, due to volatile signals regarding macroeconomic growth and monetary policy. Political uncertainty and unclear perspectives indicate greater volatility, which should force investors to focus more on fundamentals.
The rise in share prices in developed markets was the largest in Japan, Chinese shares were rising despite the lack of trend in emerging markets. The MSCI world index increased by 1.5% in the quarter and increased by 18.5% in the first nine months of the year, calculated in local currency.
Return on investment patterns changed sharply in September, stocks attractive from a fundamental point of view (value stocks) outperformed growth stocks on the growing market for the first time since the end of 2016, which was particularly evident in large American and European large companies. The trend shows how rapidly sentiment can change and why diversification of investment style is important.
Q3 2019: Regional Markets. Return rates in local currency as a percentage:
Q3 2019 Returns by investment style, global markets:
Past results and ongoing analysis do not guarantee future results.
* Japan represented by TOPIX, Australia by S&P / ASX 300, Europe excl. Great Britain by MSCI Europe excl. Great Britain, large companies in the USA through S&P 500, Great Britain through FTSE All-Share, China through MSCI ChinaA, emerging markets through MSCI Emerging Markets and American small capitalization companies through Russell 2000.
Based on MSCI World Growth and MSCI World Value in local currencies.
Source: FactSet FTSE, MSCI, Russell Investments, S&P, Tokyo Stock Exchange
Is the change in investment style short-term?
What could explain the sudden increase in value investing in September?
Style rotation may have been triggered by many factors, including relative valuations and technical factors. In our view, macroeconomic expectations have certainly played a big role. Bears moods peaked in August and gave way to small doses of good economic news. World production showed signs of life, PMI for August rose after 15 months of decline.
Bond yields reflect some of this optimism. The yield on 10-year US Treasury Department bonds reached the lowest level of 1.43% at the beginning of September, and then returned to 1.90% in the middle of the month, after which it fell to 1.68% at the end of the quarter. Indicators of economic surprises in the US and in the world have improved. It seems that the market hopes that expectations for growth may be too pessimistic, which in the case of shares that are more sensitive to the economic cycle and usually belong to the most attractively priced groups on the market, may be an incentive for their growth.
Global economic perspectives face many challenges.
Uncertainty caused by the US-China trade war remains a major obstacle to sustainable growth, especially in regions driven by manufacturing industries such as Europe and Japan. Consumption and capital expenditure have been stable up to now, but may be at risk if output growth remains low. The volatile oil prices and chaos in the Brexit case further complicate the global outlook.
This tug of war on investor sentiment will probably continue. Because expectations for the global economy are so low, any dose of good economic news can increase risk. Major central banks are expected to maintain loose monetary policy in the near future. At the same time, many geopolitical and macroeconomic threats remain unresolved, investors are easily returning to defensive positions.
Global equities have increased slightly over the past year. At the same time, EPS increased by over 4%. As a result, the price / earnings ratios for global equities have fallen by around 4% over the past 12 months, making prices more affordable than a year ago.
The 10-year US yield rate fell by around 140 basis points over the same period. As a result, the excess market return, which investors can expect from a risk-free rate of treasury bonds, has risen to its highest level in three years. If interest rates rise significantly in the long run, this premium would be at risk.
It is important to ensure effective, strategic diversification – not only in individual portfolios, but throughout the entire asset allocation. Different styles or factor exposures are prepared to succeed in different environments. With proper diversification, the investor will probably benefit. The last quarter illustrates why it is important to have contact with many styles that can generate better long-term results, although at different times.
Active managers can take advantage of today’s volatility by building positions in actions or sectors that may be temporarily incorrectly valued when emotions cover the foundations. Considering all the short-term noise, we believe that long-term investors have the chance to overcome uncertainty by focusing on business models and the foundations of the company.
* The share capital risk premium is the difference between the profitability of 12-month profit from MSCI World and the profitability of 10-year US bonds.
Source: FactSet. MSCI
The three most important threats to global economic growth in 2019.
According to SMEs surveyed by Bibby Financial Services in September, asked about three major threats to global economic growth in 2019, the political situation in the US (42%), Brexit (35%) and rising costs of raw materials (23%) were most frequently mentioned, threats similar to those defined in the 2017 survey.
– Serious doubts about global economic growth
– Global economic growth is not at risk
– Not important for local business
Prospects for global economic growth from the point of view of small and medium-sized enterprises in a survey conducted by Bibby Financial Services in 10.2019.
The most important threats to global economic growth in 2019
Source: Bibby Financial Services
A few words about alternative investments and their presence in a diversified portfolio.
Alternative investments can potentially increase the return on the portfolio and reduce the risk, but it is not easy to determine which alternative investment works best – and what proportion of the portfolio should represent. To get accurate answers, you need to look beyond traditional resource allocation methods.
A typical asset allocation approach focuses on one-dimensional risk / return transactions that do not take into account the unique attributes of alternatives – including liquidity, leverage, lack of relevant indices, difficulty in rebalancing and tail risk measurement – factors that are missing from relevant public market equivalents. To get the correct formula for alternatives, investors must take into account new risk factors when building a portfolio.
To design effective asset allocation, it is extremely important to fully understand the different types of alternatives investors can choose from. These include real estate, private equity and credit markets, hedge funds, and real estate and goods – each with their own advantages and disadvantages.
Alternative strategies can include investing in private markets, have unique returns drivers, and have a variety of return relationships with broad markets (beta risk). They can also use different levels of leverage and take clear levels of risk. And they can be illiquid, which requires investors to have a long-term attitude.
Even strategies in the same alternative category may behave quite differently, but there are some similarities between some alternatives – in particular in the area of return determinants, beta, correlations, leverage and risk – that allow for more precise classifications, factors that can help design asset allocation.
For many years, correlations were seen as a major resource allocation factor. This approach may be acceptable in liquid markets, where daily price information and transparent, well understood markets are the norm. But how should investors cope with investments that are not transparent and liquid?
An investment that is valued only once a month is likely to show a low correlation with liquid public markets. But does such a low correlation really result from the underlying behavior of the investment or simply from the fact that it is illiquid and infrequently valued?
Most traditional asset allocation methods underestimate this distinction between liquidity and the lack of it. Instead, they attribute illiquid alternatives to the same degree of low correlation to traditional stocks and bonds – simply because they are illiquid. But in practice there are differences.
A hedge fund that invests in publicly traded securities, but in an illiquid structure, is likely to have a higher correlation with global shares and greater price liquidity than a commercial real estate venture that buys residential buildings. Commercial real estate should be treated as less liquid and less correlated with public securities than a hedge fund. Conventional asset allocation does not make this distinction.
So how do you rely on conventional asset allocation approaches to take into account the unique features of illiquid alternatives?
- Asset class
The starting point is the basic principle of traditional asset allocation approaches – the type of assets. This includes assessing investor risk / return profiles to determine appropriate percentages for stocks, bonds and alternative investments.
This approach has been effective for years, but the steady flow of new products has created a larger pool of choice for investors. Because this has happened, advanced technologies have enabled the development of more precise models that take into account other dimensions of the portfolio’s design.
- Investment objective and liquidity
The second dimension involves assessing the investment objective and liquidity of each investment. We can group investments into three broad baskets – seeking return, diversifying and reducing risk. Thanks to alternative investments, we can further develop into suppliers of income and growth.
The amount allocated to each of the three broad baskets depends on investors’ expectations regarding return and risk tolerance. It is also important to consider liquidity and cash needs, goals and other factors such as portfolio tail risk, leverage and cash flow potential. Tail risk assessment is particularly important for alternatives because illiquid strategies can improve the conditions that create tough equity markets.
- Expenditure needs
Investors who use their portfolios to meet their spending needs face two additional risks: liquidity shortages and allocation. In general, it is a good idea to avoid any allocation decisions that result in a more than low probability of running out of money – especially when heavily spent on illiquid alternatives.
Allocation risk is more difficult to avoid. In each portfolio with illiquid investments, the allocation will change when the value of illiquid investments increases or decreases. But illiquid investments cannot be sold on the spot, so it can be difficult to deal with the allocation of funds. The reduction of non-liquid allocations may also increase if the investor spends higher rates than from liquid parts of the portfolio, which can be quickly exhausted. That is why it is important to set acceptable allocation ranges when investing in illiquid alternatives.
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The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.