A sunnier outlook ahead?

Analysts are bullish about the prospects for the US, UK and Europe in 2013. So is it time for pension investors to go overweight in equities? Emma Wall reports

Sunnier outlook

It’s official – equities are back in favour. The new year rhetoric of the brave is stocks and shares are where the profit is at. 2012 was the year of the Olympics, the Queen’s Diamond Jubilee and fixed interest. Predictions abound that 2013 is the year the FTSE finally breaks back through the 6,500 mark.
But is all this just a case of pension fund managers talking the talk and not walking the walk? Or are they putting investors’ money where their mouth is?
According to the latest Barclays Compass report, which looks at the outlook for 2013, investors’ appetite for equities is increasing – and the outlook for these so-called riskier assets is getting brighter.
Though the first half of the year is expected to be challenging, Kevin Gardiner, head of investment strategy EMEA at Barclays, says the outlook for both the US and the UK economies is promising.
“Investors continue to face uncertainties in 2013. Nonetheless, we believe that investors’ portfolios should be positioned with a unifying theme in mind: the outlook for the global economy, and for risk assets, is getting brighter,” he says.
Gardiner predicts interest cuts in Europe – resulting in flat growth for the region, but says that although the immediate fortunes of Asia’s economies continue to ebb and flow, Asian economies are well-positioned to capitalise on improvements on the horizon for the global economy.
With all this good fortune around, should pension fund managers be maximising their equity allocation for 2013?
According to Schroders’ head of global equities, Virginie Maisonneuve, the answer is an unequivocal ‘yes’ – because the price is right.
“Pension fund managers should be increasing their equity allocation for next year, although we would be reluctant to give a precise number because the appropriate target number depends on a host of specifics such as liabilities such as age of work force and footprint of activities. We believe that markets are still discounting a high level of bad news and that valuations are attractive. While we would caution over-reliance on the market valuation in aggregate, equity markets look cheap on a number of financial metrics,” she argues.
Oliver Gregson, head of discretionary portfolio management at Barclays, agrees. He says that though the road may be bumpy, cash and gilts should make way for equity holdings.
“With our expectation for continued volatility in the markets, it is critical that all investors, including pension fund managers, review their investment portfolio and ensure it enters 2013 in the right place,” he warns.
“Despite 2013 presenting several investment hurdles, when thinking about asset classes that may provide value next year, the outlook for equities looks relatively positive. Government bonds are expensive and don’t provide a meaningful yield at this stage. Going forward, we expect yields to rise and gilts to underperform cash. It is for these reasons that we are recommending clients manage their exposure strategically. As such we suggest investors rotate their portfolios away from cash and gilts towards equities.”
Fidelity are already doing just that. Across their multi-asset fund range they are currently positioned slightly overweight the growth assets of equities, real estates and commodities versus the value assets of fixed income and cash. Within those growth assets there is an overweight position in equities, but Fidelity says it is marginal.
Once committed to upping the equity ante, pension fund managers should be looking specifically at developed market equities, especially in continental Europe, the US and developed Asia according to Barclays.
Fidelity’s overweight in equities seems to back this view too – driven largely by the US and a small overweight to emerging markets.
But the group is positive on equities across most regions.
Julian Webb, head of DC & workplace savings at Fidelity, says: “We expect currency appreciation to be a growing theme in the emerging world given the synchronised balance sheet expansion at developed economy central banks. The Chinese economy is well placed to have a rebound in 2013; inflation has been brought under control and the leadership transition is now out of the way, suggesting policy can be accommodative.
“A US-led recovery in global growth is unlikely to be plain sailing and it could take many years to play out. However, with lead indicators troughing, US and Chinese economic indicators looking good and an easy Fed policy in place, we start 2013 in an optimistic mood. We see commodity price increases, an upward rating of stocks versus bonds and US and emerging market equity outperformance as the most likely outcomes.”
Though China is widely considered to be the superpower of the future, it is still said that if America sneezes the world gets a cold.
Therefore both the US and indeed global equities only look attractive if the fiscal cliff can be successfully navigated.
Webb says however that there are key indicators that this is possible.
“The housing market is recovering, which is a key bellweather for the broader economy, and consumer confidence is also picking up. In energy, the US could become the largest producer of both gas and oil thanks to the exploitation of its shale reserves. This will give the US a competitive advantage among advanced economies and play a central role in the renaissance of US manufacturing.”
Barclays favours developed markets equities over emerging market equities due to attractive valuations.
US equities have been the standout performers of the developed markets over the last two years and many forecasters think this is sustainable.
Of the developed markets, Barclays favours the US and Europe to Japan and the UK. It predicts that policymakers and the US consumer can drive global GDP growth to 3 to 4 per cent for 2013.
Maisonneuve even goes as far as to call the US the “bright spot” in the developed market.
The economic data certainly seems to support this, with growth predictions for the US outstripping the UK and Europe.
“Within the US, we like industrials, selected financials and consumer – especially consumer stocks with exposure at the very low and very high end of the spectrum,” she says. “China is at an inflection point, with recent data showing its growth slowdown has stabilised and should start to tick up in coming months – helped by the completion of the leadership transition which will remove a significant source of uncertainty. In Europe, the pace of deterioration is slowing and there are encouraging signs that politicians are being more supportive of growth in the short term while still addressing the region’s long term structural issues. However, against this positive backdrop, the still-unresolved fiscal cliff issue and the possibility – which is diminishing but not insignificant – of another substantial deterioration in Europe, could still add ‘colour’ to 2013.”
She also says Europe is cheap – and shouldn’t be ignored just because of the slim risk of default.
Growth will be the principal force next year according to Maisonneuve – and plenty of other forecasters agree. Morgan Stanley’s 2013 Outlook – Double Digit Upside report upgraded equities to ‘Attractive’ from ‘Neutral’ and predicted double-digit growth for European equities.
Webb said income will also play a key part in professional and private investors’ decision making process in 2013.
“With government bonds failing to provide a store of value after inflation, investors will continue to search for yield, particularly in short duration assets. In this regard, equity income remains an attractive story given the dividend yields available on equities compared to government bonds. In terms of sector and style we expect the leadership we have seen over the last year to continue. Quality will remain a powerful theme and stocks with high returns on invested capital will continue to attract a premium.”
With growth in mind, there is resounding positivity surrounding the technology sector.
Barclays said it looked for companies aligned with the secular growth themes including disruptive mobility, Big Data and cloud computing.
“Disruptive mobility has to be one of the key tech themes of the moment. Indeed we are seeing an acceleration in its trend at present, as PCs and printers decelerate harder, and the mobile computing world takes over faster, and with diverging business models between hardware, software and internet companies,” highlights Gregson. “Apple stock may have struggled of late, but that doesn’t take away from the still strong underlying trends in smartphones and tablets, and the deleterious effect they are having on the PC market.”
Webb agreed that healthcare, technology and consumer stocks remain attractive.
“There are high-quality stocks available with strong franchises which benefit from structural tailwinds, which are also returning cash to shareholders via dividends.
With strong multinational companies, investors can be fairly confident
that they will get their money back
and in the meantime, they receive a higher income than they would from investing in sovereign bonds. For instance, some pharmaceutical companies are on single-digit PE ratios despite having among the highest returns on capital.”
Technology is a big US play, as is the so-called “industrial renaissance”.
The US energy department said the country would produce 11.4 million barrels a day of oil, biofuels and liquid hydrocarbons in 2013, almost as much as Saudi Arabia.
A study by the American Chemistry Council said this shale gas bonanza had reversed the fortunes of the chemical, plastics, aluminium, iron and steel, rubber, coated metals and glass industries.
“US corporates are increasingly well positioned to compete in the global market for manufacturing and exports. This relates to what we are calling the American Industrial Renaissance. The offshoring story that was rife 10 or 20 years ago – and saw jobs and services outsourced to countries like China – is now starting to reverse, and more companies are looking to relocate back to the US. This comes amid a levelling off of US wage costs; favourable demographics; a cheap property market and improved relative energy costs,” says Gregson. “After the slowest-growth decade in half a century, it is quite likely that trend growth is stabilising – and this is a possibility which, in our view, is still not priced into capital markets.”
Outside of developed economies it is consumer staples that equities specialists favour – as the demographics of emerging nations such as China, Thailand, Indonesia, Mexico and Brazil support these types of companies.
“We would highlight consumer discretionary, industrials and materials to some extent as being exceptionally attractive,” says Maisonneuve. “In materials, the negative sentiment related to the fear of a hard landing in China in the past 18 months has opened up some interesting valuation opportunities. This might be further supported by a potential return, under the new leadership team, of China’s policy towards the urbanisation growth engine.”
Whatever investors’ equity allocation however, Webb says the most important element in a pension portfolio this year is the ability to adapt.
“The significant headwinds that equity markets will face in 2013 further highlight the need for tactical asset allocation flexibility and a well-diversified portfolio,” he says.