With tans fading, colds spreading faster than Trump’s tweets and the back-to-work blues of “La Rentrée” no longer quite so painful, it’s time to focus on what the next few months might bring.
Growth remains resilient, but autumnal storms are possible. Trade tensions, US mid-terms, EU politics and geopolitical risks are all likely to limit general equity market upside at some stage. But the forecast still looks fairly positive for specific regions, most notably the US. Bond investors (we’ll come to them properly next week) may not find conditions as favourable this fall. For now though, here are five things you could consider doing with your equity allocation:
1. Favour US equities
There’s still time left to exploit opportunities in the US. Late-cycle investing need not be fraught with danger, provided you invest selectively. US equities should continue to enjoy strong earnings-per-share (EPS) growth because of solid top-line revenues, high margins and strong share buybacks. Margin expansion may become more difficult given rising input prices and wages, but this should be offset by greater capital spending which should in turn boost productivity and help companies retain their pricing power. Some areas look set to do better than others.
We still prefer growth over value stocks, which leads to a preference for sectors like tech (where corporate profit growth is strong and margins much improved) and healthcare (given low leverage and high EPS growth). However, financials – a value play – do look attractive given rising interest rates, looser regulation and pick-up in corporate loan growth. We’re steering clear of interest-rate sensitive sectors like utilities.
2. Prepare for uncertainty in Europe
European equities have recently returned to favour with investors, probably because valuations don’t look as demanding as they do over the pond. For all that, it’s hard to be too bullish. Despite economic expansion, easy funding and the weak euro, weaker global trade and manufacturing will weigh on profit growth in the coming months. Political uncertainty in Italy will linger, while Brexit continues to befuddle. In our view, eurozone equities will continue to lag the US, so we’re no more than neutral.
There are some bright spots however. France is less exposed to global trade risks than Germany and the “Macronomic” reform agenda should lead to long-term productivity gains. Among the sectors, it’s a similar story to that playing out in the US. We like tech (despite stretched valuations) and healthcare. It’s harder to like the region’s financials however given the low rate environment and policy uncertainty. We’re avoiding sectors where earnings growth prospects have dimmed, like communication services.
In the UK, equities offer attractive dividend yields and reasonable valuations, but we do not expect to see any more sterling weakness or a further rise in oil prices, both of which would boost EPS. In truth, there’s still too much uncertainty in the air.
3. Avoid the weakest links in the emerging markets
The travails in Turkey and the angst in Argentina have led to some understandable wariness of the emerging markets (EM) – and growing trade concerns, higher oil prices and US rate hikes are among the ingredients likely to bring more volatility in the coming months. However, there are two sides to this story. Fundamentals remain supportive and corporate profit growth has strengthened. Valuations are improving, albeit unevenly across markets and sectors.
Opportunity seekers could look to Asia, where China’s fiscal easing should help limit the impact of trade tensions. Asia also stands to benefit as the US and China move part of their supply chains to the region to avoid tariffs.
China itself looks to be the value trade, with domestic-focused areas looking increasingly attractive. Indian companies meanwhile have enjoyed a long-awaited consumer-led profit recovery and better earnings could keep supporting the market even with the rupee falling and political challenges on the horizon. Debt default concerns among financials add some temporary risks to the downside. The ASEAN bloc, often used as a portfolio insulator against some of the effects of a rising dollar and Fed hikes, is however troubled by idiosyncratic issues which reduce its appeal.
Prospects in Latin America look less positive while, in EMEA, only Russia stands out as a possible destination – despite US sanctions.
4. Bide your time on Japan
Prime Minister Abe’s re-election as head of the LDP in September has helped investor sentiment improve. Over the next few months, Japanese equities will be supported by a number of factors including low rates, yen weakness and attractive valuations. Some indices play better to these themes than others. In our view, the long-term strategic case for investing in Japan remains intact but global trade issues could be a headwind for this cyclical market in the short term.
5. Chase cash-rich companies
Low leveraged cash-rich companies (mostly in healthcare and IT) are set to outperform as interest rates continue to rise. They will also enjoy, and be able to exercise, greater pricing power leading to more sustainable earnings growth.
Source: Lyxor’s Cross Asset Research and Equity Strategy teams. All views & opinion as at 4 October 2018 unless otherwise stated. Past performance is no guide to future returns.
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