26th November 2015
While markets have rallied very strongly from the August correction, the nature of the rally appears to be different from previous rallies. David Jane, co-manager of Miton’s multi-asset fund range considers the changing nature of this bull market…
We have discussed developments in the macro environment and many of the changes have been less supportive than before. In particular, the economies which have led this cycle upwards, the USA and UK, are getting ever nearer to raising interest rates while Chinese growth seems to be much lower than previously.
We have also written about equity earnings growth which has been very weak in the US, and sales have been stagnating. This has resulted in some painful falls in individual shares over the results season despite the overall index rising.
This has led to a much narrower market, led by companies which are achieving strong growth. S&P gains have been driven by heavyweights while the average share in the US has fallen since the August correction.
Looking forward, two conflicting aspects are evident.
Firstly that earnings growth is facing multiple headwinds of slow sales growth, slowing share buybacks, rising wages and rising interest charges. This may mean that forecasts for next year are likely to experience further downgrades and valuations will rise even with a flat market.
On the other side of the coin, it may be the case that the attractiveness of equity versus other asset classes becomes even greater. This is despite worsening fundamentals as rising short and longer term interest rates constrain government and corporate bond returns and stresses in the high yield market increase.
In fact, it may be the high yield market which holds the key to this dilemma. The chase for yield has driven large amounts of capital into the market both in the US and Europe, with record low rates enabling borrowers who historically would have been distressed to refinance ever more cheaply.
This has supported both economic activity and equity market valuations. How will this market respond to higher interest rates and potential falling earnings of underlying borrowers? We may be about to face the ‘classic tide goes out’ scenario across a much broader swathe of the market than already seen in the resources area.
The conflict between the deteriorating fundamentals which we can see from the data and the narrative that equities are of the best relative value versus other assets classes is what guides our strategy at present.
We are cautious on all areas of fixed income, preferring the best quality credits in less cyclical industries and at relatively short durations, avoiding the temptations to chase yield in riskier names.
In equities we remain biased towards those economies which are still embarking on monetary easing and we have made a general move away from mid-sized companies and cyclical industries into large and defensive names or strong underlying growth situations such as our disruptive technology holdings.
We will continue to closely monitor developments in the credit market as this appears to hold the key to all asset classes over the next year.