Where are the asset class investment opportunities? The chart illustrates the effect of current valuation on expected return over the next five years. Buying undervalued assets results in positive valuation returns. Buying overvalued assets results in negative valuation returns.
Slower reported 1st Quarter US growth and the impact of lower oil prices on inflation measures give the Fed room to act later rather than sooner – to postpone draining liquidity from world markets and economies. Greece continues to pose a challenge for European investors and the continent’s budding recovery. Japan’s economy struggles to establish momentum. Emerging economies around the world are dealing with a reversal of the capital inflows, which had created a lot of now idle extra capacity. Following in the footsteps of the Fed, ECB and Bank of Japan, central banks in emerging markets have been attempting to soften economic landings through more supportive monetary policies.
All central banks around the world are now singularly focused on supporting growth – and will be for the foreseeable future. This means that they will also continue, by design, to support all risky asset prices – effectively reducing the cost of debt and equity capital for financial market issuers. This also means that, with the wind at their backs, overvalued assets can potentially get more overvalued for investors.
We have found that when winds change and when economic/financial market shocks hit, valuation becomes very important. Keeping their portfolio leaning towards undervalued and away from overvalued is an investor’s best protection over time. Today this means underweighting US equities, large and small, US treasuries – especially long-term ones, China and gold. It also means overweighting equities in Japan, peripheral continental Europe, Russia and Brazil, and short term and corporate bonds.
