12 Feb 2018
Asian equity markets do not appear overvalued but gains are likely to be lower and more volatile from here.
It is always difficult to pinpoint precisely when a sell-off will occur or what will cause it (in this case it appears to be concerns around renewed inflation in the US and the effect this might have on historically low interest rates). It is too early to draw any conclusions other than reiterate that markets should not be expected to go up in a straight line and that after such a rally a correction was overdue. If economic and corporate fundamentals remain steady the correction will be a healthy one.
The crucial questions are: how big is the inflationary uptick; and will central banks respond to it correctly? Until now markets have been in an optimistic mood, enjoying the effects of improved economic growth on earnings prospects but not worrying about any associated exceptional inflationary risks. This is still probably correct. The combination of the global debt overhang, demographics and the lack of significant overheating pressures from China is likely to keep global inflation contained. This in turn should mean that global interest rate rises will be moderate. But this does not mean that nothing has changed. Volatility in markets is likely to increase from here and that in itself may reduce global confidence and global earnings estimates. Asian equity markets do not appear overvalued but gains are likely to be lower and more volatile from here.
So far we do not see signs that a significantly more defensive stance is warranted. Fundamentals are sound and we believe the portfolios we manage are well balanced, composed of companies with upside potential on a 3-5 year view. More volatile markets are usually an advantage for active managers with a long term horizon as we will look to take advantage of short term anomalies. Our aim is to deliver positive returns ahead of that of any benchmark over a 3-5 year view.
We have been taking profits in outperformers in tech and reinvested the proceeds in specific areas where valuations are undemanding such as financials which are beneficiaries of a gradual rise in interest rates. We also own companies with healthy balance sheets and strong free cash flow generation which should offer some margin of safety.
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