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April 2015 - Where is there value?

Equity and bond markets across much of the world have enjoyed the benefits of central bank quantitative easing; firstly in the US and the UK and latterly in Japan and Europe. QE is first directed at sovereign debt purchases from the banks and other institutions, which leaves them with cash to do with what they will. With loan growth rising, but very slowly, much of this cash has ended up back in the markets. Bonds are not only being bought by central banks, but knowing that there is more buying to come, other investors (speculators?) have been buying too, which has driven yields in parts of Europe below zero. Apart from the speculative component this cannot be called value by any stretch of the imagination.

Equity markets in Europe, in Germany and France in particular, have benefited hugely from ECB bond buying. Arguably they are playing catch up, having missed the train the S&P has been riding, because of concerns over the future of the eurozone. As Europe’s largest exporter, Germany should benefit from the weakness of the euro, but at the same time they face headwinds in terms of slowing export markets, particularly in China. The French economy is suffering from socialist government meddling and whilst much is made of improvements in the Club Med countries it has been from a very low base and now euro weakness is adding to import costs. So European markets are rising on a significant flow of liquidity rather that the prospects of strong, as opposed to tepid, economic growth.

In the US all appears well on the surface with unemployment close to 5% but look at the hourly earnings and this tells a different story. They have barely moved for five years; much of the US is not that well off. Earnings surprises have mostly been to the downside so far in 2015 and the equity markets can hardly be described as cheap.

Hourly earnings and Fed funds target, 01/01/1986 - 31/01/2015

So which markets haven’t benefited from the rise and rise of the S&P 500 and the mighty dollar, where might we find some value? Well of course it is in all those areas that come into the “not to be touched with a bargepole” category. Not everyone has been convinced by the Japanese three arrows strategy and missed out on some interesting gains, albeit with the currency hedged back into sterling. It just might be that dollar strength is over for the time being – the markets are saying that there won’t be a rate rise until December now having originally gone for June – so hedging probably isn't necessary and the Nikkei has a very long way to go catch up even a small part of its decades long underperformance of the world indices.

Nikkei 225 Index / MSCI World

Since 2000 it has barely marked time, and whilst a return to the excesses of the late 80s are highly unlikely, there is room for more pick up against the more expensive equity markets. Funds worth considering here are Baillie Gifford Japanese, GLG Japan Core Alpha and Neptune Japan Opportunities; the latter will be shortly launching an unhedged version of their fund.

MSCI Asia Pacific Ex Japan/ MSCI World

The Shanghai Composite has had a remarkable run on the hopes that there will be further stimulus from the government. The concern here is that speculators will be in for a very bumpy ride if the authorities decide to restrict share buying on margin. The Asia Pacific region generally has underperformed the world index since 2010 and a lull in dollar strength and better news from China would reverse this sector’s fortunes. Funds here to look at include Schroder Asian Alpha Plus and Aberdeen Asia Pacific Equity.

And finally emerging markets which have been hammered by dollar strength and commodity price weakness. With both these factors on the turn there could be a pleasant surprise awaiting investors. In the debt markets Standard Life Emerging Market Debt and Aberdeen Emerging Markets Bond are two FundCalibre Elite rated funds and for equities, Charlemagne Magna Emerging Markets Dividend and Somerset Emerging Markets Dividend Growth; are two relative newcomers, along with M&G Global Emerging Markets.

In the long term these three markets offer the potential for growth, especially in Asia and other emerging economies where the rise of the consumer will be a powerful driver.

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Clive Hale, Director – April 2015

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