It will pay to be selective when approaching global equity markets this year, Craigs Investment Partners Chris Timms says.
Globally, there would be pockets of opportunity within developed markets, especially in the preferred US direct equities.
Craigs' focus on highly cash-generative companies in defensive industries would continue to be well-placed in an environment of weak global growth and low inflation.
The US dollar was expected to strengthen and companies that generated stable US dollar cashflows remained a powerful theme for New Zealand investors, he said.
Over the past several years, global markets had operated within a relatively stable equilibrium of modest growth, low inflation and extremely accommodative monetary policy.
Equity markets had demonstrated unusually high correlations with each other and the actions of global banks, Mr Timms said.
‘‘This equilibrium has begun to unravel as investors attempt to reconcile a number of economic, monetary policy and market-performance divergences that have appeared in global markets.''
China - underweight
It was appropriate to start a discussion of global equity markets with China, he said. Not only was China topical but the outlook for the country was likely to have material impacts on global markets.
It was unprecedented for investors to have so little visibility into such a large and important economy.
‘‘We can say with some level of confidence that after decades of using fiscal policy as a primary engine to propel growth, China is now attempting to pull monetary policy levers.
''The issue for China is easier monetary policy is usually [accompanied by] capital outflows and currency weakness.''
To present an image of stability internationally, China had chosen to intervene heavily in its foreign exchange market to support its currency.
Emerging markets - underweight
It was still too early for investors to allocate
capital to emerging markets. The long-run case for Asia and India remained compelling but Craigs would prefer to invest in those regions once it was clear capital outflows and currency weakness had run their course.
United States - overweight
The US remained a bastion of relative stability in global markets, Mr Timms said.
While manufacturing data had been surprisingly weak, the consumer and services-related economy had been strong.
Within the US, the preference was for defensive sectors such as consumer staples, healthcare, financials, utilities and technology.
‘‘Our positive relative view on US equities is based to some extent on our favourable outlook for the US dollar. In our view, there are structural factors which underpin the US dollar's rise and the bull market in the US dollar likely has years to go.''
Global capital flows would continue to favour US dollar assets, which would support a higher US dollar.
United Kingdom - neutral
Craigs had downgraded its view on UK equities and the British pound to neutral following the strong performance into the general election. One of the key investment themes remained a focus on larger and higher-quality companies, Mr Timms said.
Large capitalised UK sharemarkets had an ‘‘unfortunate bias'' towards energy and materials companies, which continued to weigh on relative performance. With potential downside risks to both growth and inflation, there were no compelling reasons to allocate capital to UK smaller cap companies.
Europe - overweight
Europe continued to be viewed as a higher-risk and potentially higher-return area, he said.
European companies had depressed profit margins relative to long-run averages, in sharp contrast to US profit margins, which were at near all-time highs. As a result, European equities appeared cheap on long run valuation measures.
European economic performance had been relatively encouraging, although inflation remained stubbornly low.
‘‘We remain overweight in Europe primarily due to our view equities are attractively valued relative to other developed markets and that short to medium-term risks associated with a breakup of the euro are somewhat overdone.''
Japan - neutral
Japan was an important allocation within any global portfolio, Mr Timms said. As the third-largest global economy and home to a high number of multinational leaders, it was too important an economy to ignore.
The country's fiscal situation was not as ominous as it seemed at first glance. Japan's government debt as a percentage of GDP was the highest in the developed world at -250%. However, Japan was a wealthy country and any analysis must consider both sides of the country's balance sheet.
Household financial wealth as a percentage of GDP was 270% and net foreign assets were greater than 65% of GDP.
Of equal importance, Japan remained an export-driven country with a healthy balance of payments and was not reliant on foreign capital to fund its high levels of debt, he said.
‘‘The negative for foreign investors remains the currency exposure to a country which is actively trying to stimulate its economy by devaluing its currency.
''While we retain a neutral rating on Japanese shares due to our concerns with the long run outlook for the yen, we would be comfortable with an overweight view currency hedged.''
Market divergences
US Federal Reserve minutes suggest members expect to lift interest rates four times this year.
The European Central Bank and the Bank of Japan are considering even more experimental monetary policies. Corporate borrowing spreads and inflation expectations point to increased risk aversion among investors.
Equity prices have begun to reflect this deterioration in market internals, yet stresses in credit markets remain acute and bear close watching. Within developed markets, employment and consumption trends remain favourable.
Measures of manufacturing activity remain disappointing and many companies are struggling to increase revenue. Emerging market economic fundamentals are clearly deteriorating as global trade volumes stagnate and capital outflows accelerate.
Developed markets remain relatively resilient despite the increased importance of emerging markets to the global economy.
China continues to post reasonably strong official GDP growth rates which are unfathomably stable for such a dynamic economy.
Other measures of industrial activity point to sharply lower growth. Policy makers have allowed the yuan to weaken as capital outflows accelerate, yet the Chinese government maintains the currency will remain ‘‘relatively stable''.
