Last week, we noted why the slowing recovery doesn’t alter our belief that over the long term, there’s a case for the outperformance of equities.
While we have been arguing that a slowing economy means more volatility, as we mentioned last week, we believe the real and potential headwinds facing the global economy are already reflected in stock prices.
Currently, global developed markets are for the most part trading below their historic valuations. The MSCI World Index is trading for less than 15x trailing earnings, well below its historic price-to-earnings ratio of around 22. We see a similar picture when we look at US, where the S&P 500 is currently trading at less than 15x trailing earnings. By comparison, the long-term average is around 16.5, and the average over the past twenty-years is slightly above 20.
Today, our first call focuses on the investment implications of our case-for-equities belief. In short, as equity markets appear reasonably priced, absent a more dramatic slowdown, we maintain an overweight view of mega caps, which we view as broad global benchmarks (potential iShares solutions: IOO, OEF).
Call #2: Overweight Global Telecom
While we’ve been advocating that investors maintain equity exposure, since April we’ve been arguing that investors get their exposure through a more defensive posture. In light of this, we have maintained an overweight view of US healthcare.
Now, we are initiating a viewpoint for another defensive sector: Global Telecom. First, the sector currently looks cheap. It is trading at under 13x trailing earnings, a 15% discount to the world benchmark. Second, in an environment in which investors are still searching for yield, the dividend yield on Global Telecom is more than double the MSCI World.
Finally, this is a defensive group. Over the past decade, the volatility of this sector has been around 10% to 15% less than the broader market. Given all of these reasons, we now hold an overweight view of Global Telecom (potential iShares solution: IXP).
Call #3: Underweight Peru
Finally, we are initiating an underweight view on Peru. The Peruvian market has come under significant pressure in recent months in the run-up to, and following, the recent election of Ollanta Humala – a former army office with decidedly left-wing views – as president.
While we have no strong views on what a Humala Presidency will look like, we do believe that despite the recent sell-off, this market still looks expensive, particularly considering deteriorating economic conditions. Peruvian stocks are currently trading at a significant premium to the MSCI ACWI Index. In addition, leading economic indicators for the country are heading lower and inflation is heading higher.
Finally, Peru is a major exporter of copper and other industrial metals. To the extent global economic conditions remain weak in the near term, metal prices are likely to struggle, disproportionately hurting the Peruvian economy. Current valuations for Peruvian equities do not seem to reflect this environment (potential iShares solution: EPU).
In addition to the normal risks associated with investing, narrowly focused investments, and investments in single countries typically exhibit higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Telecommunications companies may be subject to severe competition and product obsolescence. Healthcare companies are subject to extensive government regulation and their profitability can be affected by restrictions on government reimbursement for medical expenses, rising costs of medical products and services, pricing pressure and malpractice or other litigation.