With the S&P 500 having breached 3000 index points for the first time recently, there is much fanfare and many headlines in the press trumping up this milestone. Intuitively it feels right, for much of the headline grabbing news relates either to the FAANGS or to the high quality segment of the share market – both driven in part by persistent low interest rates. Consequently, the natural investment reaction is to conclude simply that we should, as investors, be wary, even concerned. After all, price paid determines return received, and high prices should induce a negative reaction.
However, headlines can be deceiving.
The US market has, by stealth, been offering up better value in a steady trend since the start of 2018. The proportion of shares trading at low valuations has reached levels last seen almost 10 years ago. With little fanfare, there are currently over 30% of the counters in the S&P 500 trading below a PE multiple of 15 times earnings (decent value by US standards). As recently as late-2017 this ratio was around 10%. In simple terms, there are now three times as many ‘cheap’ opportunities in the S&P 500 than there were a little under two years ago. The chart below demonstrates how the composition of the S&P has changed over time with respect to which level of PE multiple the shares are trading at.
Interestingly, the proportion of shares in the highest valuation bucket (>35x PE) has grown to around 25% of the total. Most often these are the headline grabbing shares such as Netflix and Amazon, and the tendency is to extrapolate this to the entire market. But this approach is flawed, and highlights the value to be gained by firstly understanding the market risks and also by the fund managers and how they access opportunities like this. This type of disperse market suits the value oriented managers, and is one of the supporting reasons we retain a strong value bias across client portfolios, and take comfort in maintaining moderate equity allocations as there is now more opportunity than at any point in recent memory.
Locally the picture is much the same, but even more attractive with over 60% of counters trading below 15x PE (the JSE does tend to trade at a relative discount to the S&P, so we would expect this level to be higher). In addition, 30% of shares are trading under a 10x multiple. This level has slowly been reached since starting in late 2016, and we are now at a level last seen in the GFC in 2008/2009. It is still some way off the opportunity set found in the 2000 – 2003 period where almost half of the current crop of JSE shares were trading at 8x earnings or less. So while general headline news is negative, we can get a small sense of comfort knowing that the opportunities within are better than what they appear on the surface. Again, portfolio positioning is key and we also retain a preference for value oriented funds, particularly those who can access the smaller names.
Fortunately we can take comfort in these opportunities, as there is little positive news to share elsewhere. With the contraction in global interest rates once again, the same asset classes have become more expensive (global bonds, quality and growth biased shares, property and credit assets), leaving those who are wanting a decent margin of safety to underperform (any type of value biased fund – bonds or equity). There is also potential for this to remain the status quo for some time.
As before, the key risk we are concerned with remains global corporate credit, given the level of yields, quantum of debt and relatively low aggregate quality in issuance.
In South Africa, patience is a virtue in the equity market. The better spread of options highlighted above does still need a change sentiment, higher levels of capital investment and ideally no headwinds from global markets or the rand to derail a recovery.
Locally, we remain concerned with domestic property, despite the large drawdowns we have seen since the start of 2018. With many counters ‘cleaning the decks’ and suffering the consequences, it is hard to get clarity on the extent of the rot.
Overall, we remain in a cautious mindset and highly selective on asset classes, particularly offshore.
The table below provides a summary of where each asset class is currently positioned from a relative value perspective:
We have changed our outlook view (as per Table 1 below) on the following asset classes:
- Developed Market Bonds: (from (-2) to (-3)) as yields have further reduced towards 2% for US 10-year bonds, the future
expected returns are too low.
- US Equity: (from (-1) to (-2)) despite increasing diversity within and cheaper options, the index as a whole is highly valued
and there are fundamental concerns with areas like the cash component of earnings.
- Euro vs USD: (from Neutral (0) to Positive (+1)) recent USD strength has left the EUR behind.
- GBP vs USD: (from Negative (-1) to Positive (+1)) Brexit risks taking their toll, and the GBP is 25% undervalued vs PPP.
Summary Outlook per asset class