Ashburton urges caution as too much optimism about economic recovery is priced in

Ashburton Investments, the asset management arm of the FirstRand group, says that investors should exercise caution in chasing the recent recovery in stock prices as high valuations in certain regions and sectors were still a concern.

Arno Lawrenz, Global Investment Strategist at Ashburton Investments, said that the S&P500 Index was, on a forward price-earnings basis, now more expensively valued than before the large falls at the end of March when the index lost more than a third of its value. Consensus earnings forecasts have not yet dropped sufficiently to reflect the degree of economic damage being done by the global lockdown.

The S&P500 Index is an important bellwether for stock markets around the world and consists of the largest 500 US stocks weighted by market capitalisation.

“When we look at its forward price/earnings (PE) ratio based on the downward earnings revisions so far, the S&P500 is now more expensive than at the peak of the market in mid-February.

“We therefore think that market valuations are still too high, and a lot of optimism based on a view of a rapid economic recovery is priced into stocks. Investors should exercise caution and not be too hasty in chasing the recent rally.”

He noted that it would take time for economies to reopen and normal consumption patterns to resume and that the risk of further downward earnings revisions remained high.

He also said that after the shock of the recent fall investors would likely require a margin of safety through a higher equity risk premium and to hold more ‘comfort cash’, potentially cooling the demand for equities. But this cash will, in a low interest rate world, be searching for risk opportunities over time.

On a time horizon of three to five years, however, he was more positive.

“Over this period there will likely be better relative returns in equity markets than in fixed income for global investors. Yields on many developed market bonds are less than 1% and negative in some cases. Our strategic approach is to gradually increase our weightings in equities. We think it’s too early to go all in.”

He added that investors should also consider a regionally differentiated investment approach that favoured countries that had the earliest implementation measures to combat Coronavirus and the best policy backstops to help their economies.

“For example, developed markets in general have responded more quickly in implementing lockdowns and with large amounts of economic stimulus. The US Federal Reserve has added a massive stimulus backstop which will likely mean that their economy recovers more quickly, and US stocks and corporate bonds will likely also do better.”

He said that is was also important to choose resilient companies when moving back into equities.

“Tourism, hospitality and transport will take a longer time to recover but other sectors like healthcare and technology will be less affected and may even thrive.”

He concluded by saying that while the crisis was inherently disinflationary in the near term, investors’ fear of inflation, once a sustainable recovery sets in from global stimulus measures, could help gold and other inflation-linked assets.