Historically low government bonds and property yields, equity prices that continue to edge higher impervious to any geopolitical news, such as the war in Crimea, and a local currency that sustains itself at high levels despite the fact that export prices have now contracted by 30 to 40%.

The charts below highlight iron ore in Australia and dairy prices in New Zealand.

Further, there is very low volatility and other risk metrics seem benign as we approach a phase of increasing long-term interest rates as QE programmes start to wind down and China enters a period of lower growth.  It appears that the monetary authorities have becalmed markets.

 CBOE Volatility Index (VIX) 2007-2014 

Despite this, there is no doubt that the tide is in fact at a turning point. The price action of different asset classes and industry sectors we have witnessed over the last few years is unlikely to be repeated going forward and will likely be very different over the next five years

This thought process is reflected in the composition of PM CAPITAL’s equity portfolios where we have sold down a number of positions over the last twelve months, with a view that opportunities to redeploy capital would be provided at some future point in time. The basic framework we employ at PM CAPTIAL has not changed, as we firmly believe that the risk reward from owning a business is far superior to that of owning government bonds, property or cash. How superior is difficult to determine because we have an abnormally low level of global interest rates, while the valuation discrepancies in Australia are limited, which combined with the elevated currency and the minimal offshore diversification by domestic investors, would favour the perusal of international equity opportunities. The investment opportunities we are finding most interesting in global markets at present is the evolving recovery in property prices that were disseminated by the Global Financial Crisis, originally in Las Vegas, but recently we have also made investments in Ireland and Spain. There is no doubt that valuations have in fact recovered, however they are still operating under industry conditions that are well below normalised levels and there is a strong prospect of solid earnings growth looking forward, which will drive further valuation expansion. The US housing market has recovered, yet yearly sales are still at least a third below normalised trends. Spain and Ireland are additional examples of the further recovery in property prices. Ireland bore their medicine early and is further advanced in the process, but what we have seen over the last 12 months is a decent recovery in rental levels– office rentals and housing prices in Ireland. A considerable amount of foreign money is streaming into the market and prices are beginning to bid up. Spain is lagging in the process, yet we expect since bottoming late last year, combined with considerable foreign capital starting to flow in, arbitrage opportunities are emerging.

We are also attracted to a number of consumer branded companies, Google, Heineken and Anheuser however price action has not afforded us the opportunity to add to this mix, yet we believe if we are patient some of the businesses we are finding will experience headwinds in terms of near term earnings, and that will create some short term disappointment, which investors will be able to take advantage of.

By Paul Moore, Chief Investment Officer, PM CAPITAL

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Investors who remain on the lookout will benefit from changing conditions.

We’re more than half way through 2013 and after some early signs of a return to equity, it’s fairly clear that investors need to remain switched on and active with their investment allocation decisions to achieve the best possible outcome. A few months ago, amid strong gains for US and Japanese equities and a more patchy performance from emerging markets, some analysts noted a distinct reduction in correlation, which had seen markets move in lockstep with every twist and turn of risk sentiment. They saw signs that markets were returning to fundamentals, where the individual stock merits and country-level macro factors were finally beginning to re-assert themselves in place of synchronized market swings linked to global risk factors, such as Eurozone sovereign debt issues and the US fiscal cliff.

Then along came Ben Bernanke’s comments about the Fed tapering its QE policy. That sent markets into another tailspin in May, prompting an emerging markets sell-off and also a sharp rise in US Treasury yields. Fidelity Worldwide Investment’s Global CIO for Fixed Income noted that for the week ending June 26, around US$5.7 billion was pulled out of emerging market debt funds – the biggest single weekly move in the history of emerging market debt flows. Some of that has flowed back subsequently, amid signs that the US recovery and inflation outlook remain relatively subdued. But the size of the numbers involved only goes to show how many investors were forced to make a relatively sudden switch in allocations to protect their investments. Looking at Asia equities, Thailand and the Philippines saw around 20% lopped off frothy valuations after a strong run, in a broad risk-off move by investors.

And it’s not just a question of keeping on top of tactical turning points. There are clear signs that some fundamental long-term trends are reversing. A few years ago it was a useful analytical framework to talk about a “2-speed world” – roughly divided between faster-growing emerging markets and slower-growing developed markets. However, it’s becoming increasingly clear that this simple contrast is no longer sufficient. There is no “free lunch” in emerging markets anymore and investors must do their homework on which countries are offering attractive growth opportunities based on innovation, superior products and true economic reform and those countries which have simply been riding the wave of a weak dollar and related commodities boom without reforming their markets. As Reuters News recently reported, investors who have plowed some $400 billion into raw materials markets over the past 10 years are accelerating efforts to change their strategies, if not their allocations, on the growing belief that the commodities “super-cycle” has come to an end^[1].

Likewise there are clear signs that a three-decade long bull run for bonds has turned a corner, as central banks (particularly in developed markets) get set for a resumption of growth and inflation. The exact timing of interest rate rises is hotly-debated but there can be little doubt that US bonds are unlikely to test new lows anytime soon. And this takes us neatly back to the improved outlook for the US economy and by association, the US dollar. If we go back to Christmas 2012, most people who depend on financial markets for a living probably had their financial news and smartphones close to hand over a turkey lunch as the US prepared to go over the fiscal cliff amid disagreement over the US budget. However, since then there has been a marked improvement in the US fiscal and trade deficits, helped by spending cuts and rising corporate tax receipts. The US economy is continuing to grow at a reasonably healthy rate, bolstered by a steady housing recovery. There is also a growing realization that the recent breakthroughs in US shale gas extraction have the potential to revolutionize US energy supplies.

So what does this all mean for investors? It means investors need to remain active and alert and be prepared to reassess their portfolio allocation decisions regularly. Keep on top of the markets but also do your homework on long-term economic shifts.  It means that a simple, passive allocation strategy or a “choose once and leave” approach are particularly at risk of poor end results. June was a particularly bad month for many ETFs. More than anything, it means that investors need to look at fundamentals and/or invest with professionals who are dedicated to uncovering real value, growth opportunities and companies with genuine levels of competitive advantage. Thankfully some recent reversals for stock markets have not been accompanied by elevated levels of volatility – in 2008 equity volatility spiked into the 30-40% range and although it moved above 20% briefly in recent months, it has since dropped away. This means that a fundamental, bottom-up approach to investment, assessing each opportunity on its merits rather than as part of a synchronized dance driven by external factors, is once again the best approach for investors.

Article by Gareth Nicholson, Investment Commentator at Fidelity

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