Outlook 2009: skies to brighten for global equities

Market research from Internaxx: brought to you by the Luxembourg based online broker Internaxx. Market analysis is provided by Fortis Investments, the asset management arm of the Fortis group.

Equity markets fell sharply in 2008, bludgeoned by slowing global economic growth, massive deleveraging, weak earnings guidance by companies and initial signs of large job cuts. Financial markets discounted a lot of the bad news, which in our view has left equities looking attractively priced. Taking, for instance, the price/earnings relative to growth (PEG) ratio, it is at its lowest level in more than ten years. This clearly reflects the risk aversion by investors which marked 2008.

In our view, there are deeply oversold companies poised for a recovery; they should rally as the sustainability of their earnings becomes more widely recognised. There are other reasons to return to stocks that offer good earnings visibility. There are, for example, companies with strong business models and fundamentals whose stocks are now trading in line with rivals that are weaker. Overall, this means investors should focus on stock selection, rather than country or sector allocation, in 2009.

We see the downside risk to equities as limited now that dividend yields exceed the risk-free rate of return. Furthermore, the authorities’ unprecedented fiscal and monetary stimulus packages should pave the way for economic recovery within a year. Other positives include subsiding inflationary pressures and signs that the flow of credit is resuming.

With analysts increasingly making their company earnings forecasts more realistic, the market should find a floor. In 2009, disappointing earnings announcements are more likely to be met by indifference instead of the waves of selling seen in 2008. But for investor confidence to recover more fully, market volatility has to ease, interbank lending volumes have to rise and earnings visibility has to improve.

We expect the financial services sector to be at the forefront of a recovery. Well-managed, well-capitalised banks should emerge stronger from the turmoil and with the ability—for the first time in many years—to make profitable loans. Beyond this sector, we think that emerging markets valuations are becoming attractive relative to developed equity markets. Emerging markets’ strengths have been overlooked in the waves of global risk aversion and deleveraging.

Admittedly, emerging markets could see further corrections in the short term, particularly countries where household and corporate sectors borrowed heavily in low-yielding currencies. We have most confidence in countries which matched economic growth with sensible long-term policies such as China and Brazil.

Besides our call on emerging markets, we do not have a strong view on regional allocation for 2009. For now, we prefer the US to Europe and Japan due to the defensive character of the US stock market. However, given the underperformance of Europe and Japan in 2008, the relative valuations of these markets compared to the US are becoming more compelling.

Given that the economic recovery is likely to be slow and considering government’s much bigger role in the economy as well as the lingering geopolitical uncertainty and the risk of deflation, we expect equity markets to regain their composure only slowly in 2009. However, in view of the current valuations, there is potential for a gain of roughly 20%, taking us back to September 2008 levels. In our opinion, this is an attractive environment for long-term investors since there are unprecedented risk premiums to be captured.

Outlook 2009: global property (source: Fortis Investments)

Global property markets have been dominated by extreme volatility caused by the deepening credit crisis and worsening economic outlook this year.

While the credit crisis has affected all asset classes, listed property has suffered more than most other segments of the market. This is because property companies are considerably more leveraged than businesses in other sectors. The virtual collapse of credit markets led to higher borrowing costs for property companies, forcing them to downgrade their earnings guidance. This in turn put their share prices under pressure.

Valuations certainly look appealing according to a range of metrics. The spread of dividend yields over bonds as well as price-to-earnings multiples and discounts to net asset value (NAV) are well below their historical averages. The extraordinary negative yield gap that prevailed in markets such as the UK during the spendthrift years of the property sector in general—between 2005 and 2007—has been replaced by healthy premiums over long-term government bonds. Equally, discounts to NAV in a range of markets across the world are considerably below their historical averages.

A key catalyst for listed property will be a return of confidence in the credit markets. When lenders open their doors again we should start to see transactions in the direct property markets underpinning share prices. An additional challenge will be the length and depth of the recession in Europe and the US. A depression is certainly not priced into current share price valuations.

Moreover, while share prices may look attractive, investors still appear to think they are too good to be true. For example, it is questionable whether some companies will be able to pay out the large dividends implied by their current valuations.

In addition, the discounts to NAV implied by current prices are only as credible as the valuations of the properties the companies own. The lack of transactions in the underlying direct markets provides little or no support for these NAVs. So in a market driven by sentiment, fundamental long-term investors need to approach all current valuation metrics with a degree of caution.

We expect quality and balance-sheet strength to remain prevalent investment themes in 2009. Companies with solid balance sheets will probably find themselves in a position to start picking up bargains in the form of high-end assets or portfolios. Merger and acquisition activity may also start to resurface once banks regain their nerve. In the direct property markets, we expect values to continue to fall.

The key for investors will be taking defensive positions both within countries and within sub-industries in companies that are valued realistically and which have high quality assets that are less exposed to vacancies, payment arrears and capital value declines in the direct markets.

Internaxx Top ten buys and sells –International Investors Activity summary from Internaxx

DISCLAIMER
This document has been prepared solely for informational purposes and does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any security or financial instrument, or any investment advice. Prospective investors should conduct such investigations as deemed necessary and should seek their own legal, accounting and tax advice to determine independently of the suitability and consequences of an investment.