Investors must refocus on capital preservation and value opportunities

Dan Kemp, Chief Investment Officer for Morningstar Investment Management EMEA.

Uncertainty persists over the justification for 2016’s positive market returns and valuation pressures continue to mount. Morningstar Investment Management Europe Ltd see scope for increased investor caution and a greater focus on capital preservation among long-term investors. Notwithstanding the broad valuation headwinds, they cite some compelling valuation opportunities, including a medium to high conviction in emerging markets, European financials and sterling.

“While questions persist as to whether Donald Trump’s election is a game changer in terms of US economic growth, the availability of this news is tempting investors to speculate on the cyclical or structural nature of reflation. This, in turn, risks sending them on a path of short-termism and sector rotation. However, investing is always a long-term endeavour and so this temptation must be resisted.

“If 2016 contained just one lesson, it is to avoid being whipsawed by changes in short-term sentiment. Investors are likely to face similar challenges in 2017 and therefore must do their best to shut out the siren song of forecasters. Looking ahead through a valuation lens, there are many more hurdles to jump. Bond yields are still largely negative in Germany and Japan (out to a 7-year maturity) and Eurozone sustainability is far from secure. Most critically, valuation pressures continue to mount in many key markets. This should create a growing sense of caution among prudent investors, especially those relying on fixed income investments to protect them against a decline in equity prices.

“The strong returns in many markets through 2016 appear unsustainable in a long-term context as asset prices are subject to the gravity of fundamental valuation. As prices become dislocated from fair value, we will inevitably become more focused on the preservation of capital, while thoughtfully allocating assets towards pockets of opportunity that offer compelling valuation advantages and a margin of safety. These pockets of opportunity include emerging market equities and debt; European financials where much of the downside is priced in; and sterling, which still appears undervalued relative to the US dollar.”