Despite a climate of increasing investor caution, equity markets have performed relatively well since the financial crisis and now represent “reasonable value”, according to Towers Watson.
In its November Global Markets Overview report, the global professional services firm moved global equities markets to a “moderately attractive” rating on its three-year horizon scale – up from a “neutral” rating in October.
“On a forward-looking basis, our models imply various asset markets (equity and debt) are pricing too pessimistic an outcome for future global growth,” the report states. “We therefore believe that equities, a pro-growth asset, are under-pricing our base case scenario and appear moderately attractive.”
The report anticipates “continued moderate returns” for equity holders, particularly in the medium term, claiming that “for the first time in many years, the medium term risks for equities are skewed to the upside”.
This increased attractiveness is attributed to several factors, the “robust” condition of corporate balance sheets chief among them. In addition, monetary policy, weak wage growth and low financing costs are also credited with the improvement in outlook for returns on equities investments, aided by a “moderate improvement in investor sentiment from very low levels”.
Other asset classes, meanwhile, have retained their ratings from previous months. Global credit (investment grade) and commodities have stayed level at a “neutral” rating while once again, global government bonds and global inflation-linked bonds have been described as “highly unattractive”.
Indeed, the report anticipates “likely negative returns” for investments in bonds and “close to zero” returns from nominal cash rates.
The report states that its findings have been confirmed by a range of valuation metrics, including the plotting of market earnings yields against various bond and credit yields, and a comparison of current metrics with historic distributions of values.
However, despite the slightly rosier outlook for equities returns, institutional investors might still think twice before they rush to stock up on this asset class.
In March, former treasury secretary Ken Henry indicated publicly that the Australian super system was over-exposed to equities, calling on super funds to re-allocate and spread assets across a range of fixed interest investments.
Similarly, David Brown, chairman of the Australian Private Equity & Venture Capital Association, told Investor Weekly in April that super funds were over-investing in the domestic stock market, recommending diversification and singling out private equity funds as a worthy investment prospect.
“When you have a highly concentrated stock market in financials and miners, with super funds owning 30 per cent of the stock markets, any government – of any flavour – has a problem,” he said.
In response to these calls, Pauline Vamos, CEO of the Association of Superannuation Funds of Australia (ASFA), said “whether it’s equity or debt, the underlying investment is still in Australian corporates”.
Beyond the super fund asset allocation debate, the Towers Watson report also places a caveat on its finding that the projections were not set in stone and are susceptible to market volatility.
“Whilst we believe recent policymaker moves have removed some of the ‘left tails’ of outcomes we continue to believe the global economy remains susceptible to further shocks,” the report states. “A further escalation in problems in the Eurozone, a bungling of the fiscal cliff negotiations in the US or a further growth downturn in China could all derail our base case.”
When viewed against a backdrop of such uncertainty, the increased rating of equities to “moderately attractive” may be of small comfort.
