Why valuations are the key factor in generating returns

Why valuations are the key factor in generating returns

Why valuations are the key factor in generating returns Uncertainty: a word that seems to have pervaded the global markets for some time; a word that makes many advisors and portfolio managers feel like broken records. Yet despite the repetition of the term, market uncertainty remains and is poised to play an even more important role this year than it has for a while. But how can advisors start to mitigate current market conditions and help their clients achieve some good returns?
 
“When I think about it from a 50,000 foot level, the issue that remains similar to prior years is the importance of the types of equities you own,” explains Scott Newman, Vice President, Team Lead, Global Investment Strategist at Invesco. “It’s difficult and dangerous to get caught up in a narrative that says stocks are really expensive. At first glance, most equity markets look expensive, but I’d argue that these higher valuations do mask rather extreme valuation disparities both regionally and within sectors.”
 
Over the last number of years, valuations have taken a back seat to global monetary policy, in the form of quantitative easing and low interest rates. But there is a broad belief that valuations will be the key factor in driving returns. The impact of recent monetary policy decisions has, however, pushed up valuations in certain segments of the market, and any type of stock that exhibits bond-like qualities has benefitted from low interest rates.
 
“We call those defensive stocks: durables and consumer staples. They don’t experience rapid growth and don’t really benefit from a growing economy, but they’re very stable and they pay a decent dividend,” Newman says. “We saw some rotation out of those stocks in the last month or two of the year. From a broader perspective, the notion of valuations driving returns is highlighted by the best performing markets last year globally. They are the markets that no one wanted to touch – Brazil (returns of 65%+) Russia (30%+), and China (5.5%).”
 
Over the past six to 12 months, many equity managers have been reducing exposure to those bond-type surrogates and increased portfolio exposure to high quality cyclicals, namely consumer discretionary stocks and industrials.
 
"Regionally, we’ve taken advantage of valuation discrepancies in the emerging markets as well,” Newman says. “While you won’t see us have a 50% weighting in a conservative global equity fund to the emerging markets because it goes against some of the volatility goals that we try to focus on. However, we certainly have found opportunities to add names from these regions that just happen to be in markets that have been depressed. Those positions have served unitholders quite well.”
 
“We’re not suggesting you buy a Brazilian country ETF and roll the dice, but it speaks to the idea that what you own is really going to matter. Are you willing and able to sift through some of the noise to find opportunities in 2017?”


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