According to current valuations, global equities offer opportunities

The current economic environment remains challenging and both economists and investors find it difficult to know what to expect. In spite of this, there are opportunities for those investors who are willing and able to face some short-term volatility.

To identify these opportunities, David Knee, Head of Fixed Interest and Tactical Asset Allocation at Prudential Portfolio Managers says that investors should focus on valuations, rather than try to forecast the timing and manner of any economic recovery. Forecasters have been continually wrong-footed post the financial crisis. The result of this has been bouts of rising volatility in the markets and rapid changes in risk asset pricing.

Among selected local assets, valuations show that equities look promising over the medium-term

According to Knee, the answer to where valuations indicate opportunity possibly lies in equities. In fact, he believes that investors who have long-term investment horizons and who do not have enough exposure to equities are putting themselves at risk.

“Based on their long-term valuation anchors for different asset classes, the prospective medium-term returns for South African equities currently stand at around 14% per annum. Long-term corporate bonds are lagging quite a few percentage points behind at about 9%, but still offer a useful return enhancement over long-term government bonds, which have prospective returns of below 8%.”

“The return prospects for these asset classes – specifically equities – are much more compelling than the prospects for cash at 5.5%,” he explains. This is despite the fact that many investors have fled to cash in the uncertain economic climate.

But not every investor’s risk appetite is healthy enough for equities

But applying these results in practice is easier said than done. As Knee says, “Buying equities now, in a world of massive economic uncertainty when equities have just rallied 20% since last August feels extremely uncomfortable.”

“Internationally, bond yields in developed markets are astoundingly low and equities appear priced for a full-blown earnings recession,” he adds.

Hence equity prices are well below their long-term valuations. This is why Knee argues that to return to long-term fair value, markets would actually have to double. This is a big call for anyone watching the markets rise and fall daily but even a modest re-rating of world stock markets would yield handsome double digit returns in hard currency terms.

Knee concludes by reminding long-term equity investors to stay calm and avoid the flight to cash, “The best investors see opportunity in adversity.”