Few pockets of value remain for a contrarians to exploit. David Liddell sets the scene and suggests three trusts that should prove resilient.
Harold McMillan is reported to have responded, ‘events, dear boy, events', when asked what worried him. Well nothing seemed to worry the stock market in the first half of 2017: from Trumpian political farce through to a more hawkish Federal Reserve and an unexpected UK election result which left the Conservatives as the largest party in a hung parliament.
Through it all the FTSE All-Share index kept its cool. Over the six months to 30 June 2017 it gained 3.3 per cent; admittedly overseas markets were more than supportive, with the S&P 500 up 8.2 per cent, and the German and French markets increasing by 7.4 per cent and 5.3 per cent respectively (in local currency terms).
Europe was a bright spot both politically, where Macron’s success in the French election calmed fears of a populist surge, and economically. For example, the eurozone Purchasing Managers’ Index hit its highest level for six years in June.
So where to look for value in a world where stock markets have already had a good run and which is perhaps more than usually full of potential ‘events’? Not least of these is the recent focus on a possible end to the ‘easy money’ that quantitative easing has provided in the UK and Europe.
One possible hunting ground is emerging markets (EM). In terms of valuation at least, despite a good run over the year to date, these are generally at a discount to most developed markets.
If we exclude the US market, which most commentators would accept may distort world stock market valuations to the upside, and consider therefore the MSCI World ex US index, this is on a price/earnings (p/e) ratio of 19.3 and a forward p/e of 14.7, as at 30 June. The price-to-book ratio is 1.7 times.
The equivalent figures for the MSCI Emerging Markets index are a p/e of 14.9 and a forward p/e of 12.2 and also 1.7 for price-to-book.
Looking at longer-term performance over five years the average EM investment trust has a total return of 53.1 per cent compared to 101.2 per cent for global investment trusts. Of course this performance lag reflects to some extent the combination of previous exuberance and the decline in many commodity prices, which itself was derived from a slowdown in Chinese construction and manufacturing.
What are the current economic fundamentals? Mixed is probably a fair assessment of China. According to Caixin/IHS Markit, the seasonally adjusted Chinese PMI – a composite indicator designed to provide a single figure snapshot of operating conditions in the manufacturing economy – is just slightly above the 50 no-change mark. However, operating conditions have strengthened in nine of the past 10 months, it says.
Of course there are concerns about debt levels but the big prize remains the extent to which consumer spending supersedes manufacturing as the driver of economic growth. The possibilities here are still immense and surely not reflected in somewhat subdued valuations.
We go for a generalist trust, JPMorgan Emerging Markets (JMG), which lists its most recent geographical exposures as: China (22.1 per cent), India (22), South Africa (12.4), Brazil (11.7), Taiwan (9.3), Indonesia (5.3)and others at 17.2 per cent. An alternative would be to go for a straight China play such as Fidelity China Special Situations (FCSS).
The true contrarian might be tempted by the net short holdings (i.e. positioned to take advantage of a fall in prices) of Sanditon Investment Trust (SIT). But a slightly lower risk option is the sterling class of Third Point Offshore Investors (TPOG). Although the dealing spread is quite wide, the shares stand at a discount of over 17 per cent and last year it paid a dividend equivalent to nearly 4.5 per cent.
The exposure is mainly US, which does cause some misgivings, but the underlying fund has recently taken a large position in Nestlé, in a well-publicised move. Higher interest rates and more volatility should be conducive to a reasonable performance.
The UK market is perhaps the most difficult to call. Whilst apparently attractive in terms of relative valuation and a high dividend yield, it nonetheless has the spectre of Brexit hanging over it. In the face of this uncertainty we are looking for a trust that has a mixture of large and small company exposure, coupled with a value approach.
One such is Lowland Investment Trust (LWI), which also happens to be standing at a reasonable discount of 5 per cent and provides a yield of 3.1 per cent.
The author is founder of investment trust advisory service IpsoFacto, which offers a free two-month trial to new subscribers.
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