Mutual fund managers as a group, are generally pretty reticent about making prognostications about the future – typically preferring to leave such educated guessing to economists.Still, “bottom-up” stock picking persuasions or no, these front line observers are well placed to view the world’s economies, their machinations, and how they have an impact on asset values.
Lately fund managers say things are getting better – slowly.
Chinese demand is an ever-present concern, Japanese officials have a lot of people on edge with their latest deflation-fighting efforts, and all of the managers we spoke with say companies are beginning to trade a little high, relative to their valuations.
“Right now, the market has generally priced in decent growth. It largely seems fair on an absolute basis,” says David Ragan, director at Mawer Investment Management, and portfolio manager for the Mawer International Equity Fund. “Around the world, the high quality companies are probably too expensive. They’re overpriced. The low quality companies are probably underpriced. The very low quality companies, especially the (low quality) financial companies, are probably the cheapest thing on the market.”
Although he says the opportunities are more difficult to find, even relative to the effort it took a year ago, some still exist. “They’re just less pronounced.”
In looking at the big picture after the fact, Mr. Ragan’s fund has been active in Europe in particular, “because everyone has everything overpriced in Asia. We’re finding great opportunities there,” he says of the fund’s prospects in Europe. “Now it’s more of a mixed bag.” Economic growth, meanwhile, will likely piggyback on growth in the United States and Asia. “If all goes well, the European economic situation should improve over the next few years. If it doesn’t, they will probably struggle a little longer.”
Trading on fundamentals
On a more positive note, some managers observe that some sense has returned to markets in general for a time – stock correlations are down, and more shares appear to be trading according to company fundamentals.
“It does feel different today,” says Dale Hanks, investment specialist at the Capital Group Companies, manager of the Capital International funds. “The markets have started to trade more on company fundamentals. Correlations have come down. When correlations are high, all stocks tend to move in the same direction at the same time. If it was a good day, they’d all be going up. If it was a bad day, they’d all be going down. What we’ve seen over the last six months or so, is an increased dispersion, lower correlations, and to a degree, markets that are focusing on individual company fundamentals. Another recurring theme, meanwhile, is optimism, albeit a somewhat tempered optimism, about U.S. housing markets.
Jason Whiting is vice president at Trimark Investments, part of Invesco Canada, and part of the company’s small cap investment team responsible for the Trimark US Small Companies Class among others. Along with Mr. Ragan, he points to the U.S. as one of the few relative or potential bright spots within the larger picture. “I think things are slowly getting better in most places, or at least not getting worse,” he says. “If this U.S. housing turn is real and sustainable, I think that could be even more positive than people are expecting.”
Back at home, Chinese demand is a relatively perennial concern for Canadian investors. With stories and news images emerging about entire ghost cities being built without demand or people to occupy them, that worry about a slowdown in demand for materials and commodities becomes decidedly less theoretical or hypothetical than it has been in the past.
“China worries me a fair bit,” Mr. Whiting agrees. Unlike an economy driven by consumption or services, he says the sustainability of an investment boom fueled by massive capital spending, is suspect. “If you build a subway system, you don’t need a second one,” he says.
Canada would not be alone in feeling the pain if Chinese demand were to falter either. In one case, Mr. Whiting points out that China is Germany’s largest export market. “Germany likes to build things that make things – mostly capital equipment,” he says. Similarly, the U.S. exports both capital equipment (think John Deere tractors), and intellectual property, even if a great deal of it is pirated. In yet another example, even an iPhone manufactured in China to meet Chinese demand adds value to Apple Inc., an American company.
“They’re such a big consumer of everything. If there are any significant stumbles in China, it’s probably a negative for the world in general.”
In Japan meanwhile, the new central bank governor is breaking with the country’s “traditionally hyper-cautious” monetary policy in a dramatic way. Governor Haruhiko Kuroda announced in April that the Bank of Japan (BoJ) plans to double down on its purchase of government bonds, and to print money, a lot of it, flooding the market with yen, reportedly doubling the country’s monetary base.
“It seems to be a fairly legitimate, strong push to increase liquidity, which helps the country as an exporter,” Mr. Ragan says. Mr. Whiting calls the move “a pretty dramatic experiment.”
“They’ve never done it this aggressively before.”
Still, reports that failure could bankrupt the country notwithstanding, the move would appear to be putting investors on edge for two additional reasons as well: The first is Japan’s track record. The country has never emerged from the fallout when industrial production, and property price bubbles burst, and share prices collapsed in the 1980s, causing many today to take a wait and see approach. “They have a pretty strong track record of screwing up any sort of recovery,” says Mr. Ragan.
Second is the effect cheap yen will have on export markets. Although the BoJ’s new monetary policy will help Japan’s exports, this boost could have other countries in the region considering protectionist measures.
With the yen cheap, and Japan’s market strong, as has been the case, “it has an impact on companies in other countries,” says Mr. Hanks. “Companies in South Korea, for example, that compete with Japanese companies are hurt by the competitive devaluation of the yen. There are policy responses that could come down the road. That would be a worry."
Canadian investors and the future
Other existing concerns are also related to future policy decisions. Mr. Whiting points out that people are negative about the Bank of Canada’s accommodating stance. Although he says today’s monetary policies are likely creating problems down the road, he says things would likely be a lot worse than they are today without it.
“I do think there’s potential for some bubbles. People always think we’ve got to keep Canada competitive versus the U.S., so rates in Canada are probably lower than they should be, relative to our economy,” he says. “I think that’s creating a housing bubble.” He also says high-yield debt is an area of concern.
The sentiment is echoed by Fidelity Investments portfolio manager, Dan Dupont, head of the Fidelity Large Cap Fund.
“In the last six months, the drop, every month, in the price of residential real estate nationwide has gone mostly unnoticed,” he says. “There are a lot of discussions about a slowing real estate market, but I’ve had several savvy people tell me house prices have not started coming down. In fact, they have. I think it’s going to be gradual, but I think it will be fairly significant.”
This, in turn, he says could lead to the government being forced to supply more capital to the Canadian Mortgage and Housing Corporation. A drop in housing prices would also mean duress for Canadian consumers.
Investors, meanwhile, he says are too heavily invested in Canadian companies. Whether he’s looking at company valuations in Canada or abroad, any bond-like stocks – pipelines, utilities, real estate trusts and others – have all been priced higher as investors search for yield. Compared to foreign securities, anything in Canada which isn’t related to the struggling resource sector, is overpriced today.
“BCE (Bell Canada Enterprises), for example, trades at 15, 16 times earnings. Vodaphone (Group PLC) is a higher-quality European based telecom company, and it’s trading at 11 times earnings. There are significant discrepancies, pretty much across the board. We have pipelines trading at 25 times earnings, which under any kind of scenario is at least a little bit aggressive,” he says.
“Canada as a country has been doing really well over the last 10 years. Our stock market has been doing really well and our currency has been doing really well, and the average Canadian, at this point, is significantly overweight in Canadian assets. I think this is going to start to change because we’ve seen some relative outperformance from foreign assets. I believe it’s warranted, and that it should change. The average Canadian investor is too highly weighted in Canadian assets at this point.