Global equity valuations look fairer over the longer term.

Equity valuations are inflated in the US and with more downside risk in 2024, investors should steer towards quality companies to avoid exposing their portfolios to riskier companies which could suffer on any signs of corporate earnings weakness, according to abrdn chief investment officer Peter Branner.

While equity valuations are more reasonable away from US markets, macroeconomic challenges remain and suggest investors should be cautious about the year ahead across global equity markets.

“With global growth running out of steam, it’s reasonable to expect that not all companies will be in a position to thrive this year.

“Uncertainty over inflation, peaking interest rates and lower economic growth rates present headwinds for corporate earnings this year. A focus on quality provides the best means of navigating this environment.

“History shows that companies with pricing power, strong balance sheets, durable competitive advantages and less cyclical earnings are better placed to deliver against expectations than the broader market,” he said.

According to Mr Branner, the wide range of economic scenarios suggests investors should focus on company fundamentals such as the strength of their balance sheets, ability to create cash flows and debt levels. As such, stock selection will be key to investors’ success.“Steering capital towards quality businesses and investing for the long term are the best ways to mitigate equity risk and build exposure to sustainable earnings growth.“The ability of quality businesses to demonstrate greater resilience and do better in a range of economic scenarios make them look appealing in uncertain times, over the short and longer term,” he said.

According to abrdn global head of equities, Devan Kaloo, global equity valuations look fairer over the longer term, with cyclically adjusted price-to-earnings ratios (CAPE) ratios are in the middle of their historic range.

“Equity prices in the middle of the CAPE range imply annualised returns of eight per cent over the next decade^[1]. These are comfortably higher than US ten-year Treasury bond yields and in line with average global equity returns investors have enjoyed over the past 20 years.

“That makes global equities an attractive investment. In the short term, though, we see little support from valuations, and earnings are likely to be the primary driver of markets this year,” he said.

Mr Kaloo said equity valuation diversity suggests it may pay to look outside the US. China’s disappointing recovery has weighed on emerging markets however there is room to be selectively optimistic at the stock level.

“This is reinforced by the opportunity for policy support to gradually stabilise China’s property sector and boost consumer confidence. Additionally, attractive valuations versus other regions provide a reasonable starting point for stronger Chinese equity returns this year.

“Japan is another market that’s worthy of investor attention on account of an ongoing period of progressive structural change. Recent corporate governance reform has been well received by the market and is likely to continue to drive shareholder value. Alongside a pickup in household spending, we see Japanese equities being well placed to extend gains,” said Mr Kaloo.

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Notes:
[1] Source: Refinitiv Datastream, Barclays Private Bank, October 2023

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Mr Kaloo said despite the asset class being under-owned by local and global investors, the global asset manager remains ‘cautiously optimistic’ about EM equities.

“It continues to present a fascinating range of opportunities for active investors, and India in particular is one of the best long-term stories in the sector, with a number of factors working in its favour.

“Prime Minister Narendra Modi has done a good job at continuing the infrastructure projects which commenced under the previous administration. Today, everyone has a digital financial network and access to money, which has been transformational.

“Perhaps more critically, India is a strong beneficiary of the US/China tensions, and we’re seeing many companies shifting production and manufacturing into India which will only likely increase from here. It will lead to a ‘who’s best friends with India’ scenario,” he said.

However, Mr Kaloo said the main issue plaguing investors is India remains expensive, relative to other EM jurisdictions. He said a potential investment rally in China will likely see some rotation out of India and into China.

“We do remain cautious about current levels in India, and if there was to be some rotation into China, India would effectively become cheaper and we would look to add to our exposure there,” he said.

Commenting further on investment positions across the EM equities sector, Mr Kaloo said the asset manager would more than likely be increasing – rather than reducing – it’s exposure to China in the short to medium term, remaining undeterred about the fallout in the property market.

He said despite this, there are still issues within China that need to be resolved with the external trading environment remaining difficult for many companies.

“We’re keen on companies with clear earnings visibility over the next two plus years. I’m sceptical about the plausibility of a soft landing in the US. The US Fed funds rate has gone up 500 basis points – it’s not going to be consequence-free for that economy. It’s a much tougher operating environment so you want companies who have the ability to deliver earnings.

“The dollar, earnings per share and China not stabilising is a problem and you can’t get away from it, but on those three things, we’re relatively positive and believe we’re at an inflection point,” he said.

Mr Kaloo points to a Taiwanese semiconductor manufacturing company as an example of a company with clear visibility of earnings.

“It dominates the chain – regardless if you’re talking about AI, increasing handset rollouts or investment in digitalisation, they make the chips that go into that, and are a very good investment play.

“We see them navigating the US/China tensions very well, and for the company and other like-companies who can steer clear of the geopolitical issues, it means they have sizable capability to invest.

“Also, the stock is cheap, and with a rerating of US companies, it continues to trade at good multiples while giving investors good exposure to the tech recovery story,” he said.

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