Value is cheap relative to history, says M&G

by , 4th March 2018

Value is one of the more attractive parts of the market, according to Ritu Vohora, Investment Director at M&G. That’s because value stocks are cheap compared to historic levels, and because value stocks tend to do well in an environment of rising interest rates. Vohora’s view is shared by Rob Arnott of Research Affiliates, the smart beta guru.

Vohora also thinks that growth is ‘the scariest trade’ in 2018. It’s no secret that the valuations for many of the best known growth stocks look very high and it’s these stocks that could be most vulnerable in any upcoming market turbulence. At a presentation this week Vohora argued that the two most crowded trades in recent years have been technology stocks – because of their non-cyclical nature – and ‘bond proxy’ stocks such as utilities and consumer firms. Technology stocks are now vulnerable because valuations are high, while bond proxies will inevitably be less attractive as interest rates rise.

Along with value, Vohora is also positive on emerging markets equities. Several countries have pushed through structural reform, debts have come down, and current account deficits have also fallen. She particularly likes Brazil, Taiwan, Thailand and South Korea. However, Vohora did say that ‘you have to be careful’ and argued that Mexico and India are expensive.

Looking at potential downsides, Vohora highlighted concerns about a new protectionist trade war. Vohora made these comments before President Trump announced tariffs on steel and aluminium. Her concerns now seem all the more valid.

Powell put

Another M&G manager, Jim Leaviss, wondered if equites might benefit from a ‘Jerome Powell put’ in the next couple of years. Leaviss pointed out that Trump seems to set great store by the level of the US stock market; if rising interest rates hit the Dow, Trump might pressure his new Fed Chair (Powell) to ease up on rate rises.

Leaviss is a highly regarded manager of three bond funds and accepts that most bonds don’t offer value at the moment. He expects rates and bond yields to rise. That’s mainly because central banks in the US and Europe have made it clear that they have started to wind back from Quantitative Easing (QE). In fact, we’re now in a world of QT (Quantitative Tightening.) The secondary reason for higher bond yields is Trump’s decision to push through tax cuts when we’re close to the top of an economic cycle. All other things being equal, that should boost inflation and lead to higher interest rates and bond yields. (However the ‘Powell put’ might work against that.)

It’s also worth noting that Leaviss thinks there is a ‘cap’ on rate rises. Put simply, he thinks the currently buoyant global economy couldn’t cope with too big a rise in bond yields.

Property

An M&G property expert also spoke at the presentation. Richard Gwilliam, the Head of Property Research at M&G, is still relatively upbeat about commercial property in the UK. He pointed out that the yield on UK property is still about 5 percentage points higher than yields on 10-year gilt. Historically, the average spread has been around 2.5 percentage points.

Gwilliam said: ‘Yes, interest rates and bond yields will rise, but there is a large buffer which can absorb a fair bit of quantitative tightening. ‘

He also argued that interest rate rises aren’t necessarily bad for property, especially in the short term, and that property yields often don’t move in line with bond yields. A big attraction of commercial property is that it can give you some protection against inflation and in the UK, a lot of properties have inflation-linked rates. That protection against inflation makes property an attractive asset even when rates are rising.

Property has also been affected by a big structural issue: the decline of ‘bricks and mortar’ retailers as online shopping becomes more and more popular. At the same time, industrial properties have been in demand as online retailers look for more warehouses and distribution centres. Interestingly Gwilliam thinks there’s further room to grow here: ‘it’s still fairly early in the cycle on how much distribution capacity has been built…rents are going to carry on going up.’

Gwilliam also said that ‘leverage isn’t really an issue’ in UK commercial property. He doesn’t think leverage will trigger the next property downturn.’

2016

The other point that came out of the presentation was that 2016 was the year of ‘regime change’. You might think that 2018 would prove to be the big watershed year as quantitative easing kicked in, but M&G argued that 2016 was the watershed as investors became much more optimistic about the global economy at that point. In summary, investors became much less concerned about debt and deflation two years ago.

And with that change, asset allocation became much more important. Between 2006 and 2016, all major asset classes went up and the rises were well correlated. The Great Financial Crisis in 2009 was scary at that time, but it only triggered a temporary fall in asset values. Rises across all assets seem much less likely now, so it’s worth spending more time on asset allocation. Of course, your allocation depends on your own individual circumstances, but for me a tilt towards value and emerging markets makes a lot of sense. That doesn’t mean putting all your money into those two areas, but you should certainly consider upping your weightings here.

How to invest

ETFs can be a great way to tilt your portfolio towards value by using smart beta funds. Here are three value ETFs to consider:

Lyxor SG Global Value Beta (SGVL)  – this is a global value ETF

iShares Edge MSCI USA Value Factor (IUVD) – this gives exposure to US value stocks

PowerShares FTSE RAFI UK 100 ETF (PSRU) – Although value isn’t in the title, this is basically a value ETF. The underlying index for the fund is managed by Research Associates, which is Rob Arnott’s business.

If you want to find out more about investing in emerging markets via ETFs, read Investing in emerging market equities.  

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