Asset managers search for value and quality in expensive equity markets

Valuation

Equities markets are overvalued and expensive, if you ask asset managers. A survey this month of global fund managers by Bank of America Merrill Lynch showed that 78 per cent believe that stock markets are currently overvalued, which marks the highest level since the closely-watched survey began in 1998.

The S&P 500 has already rallied almost 40 per cent off March’s coronavirus sell-off lows, and prices have kept rising even as company earnings forecasts were slashed, which has sent the forward price-earnings ratio up to over 23 times. 

“Equity markets are too high from a standpoint of the value of future earnings. This has been spurred on by stimulus but is not at all sustainable. We see a second correction striking,” says Simon Black of wealth manager Dolfin.

Markets have reflected increasing optimism about the effectiveness of government and central bank stimulus to spur economic recovery. In the same Bank of America survey, 46 per cent of participants said they expect a prolonged recession, dramatically down from an overwhelming 93 per cent in April.

Black says that Dolfin, which has about USD4.1 billion of client assets on its platform, is choosing to remain ‘very underweight equities’ (6 per cent of the portfolio), but he says that untenable valuations are forcing the asset manager to rethink conventional wisdom about how to manage a portfolio.

“We’ve had to change, adapt, and adjust what a ‘balanced portfolio’ is. It used to be that a balanced portfolio was 50 per cent fixed income, 50 per cent equities. The starting point is the ten-year government bond, which when yielding 4 per cent, gives a 2 per cent kick through the portfolio, meaning that equity allocations are going to have to give you 4 to 6 per cent return in order to generate 4 per cent to 5 percent each year at a portfolio level.”

“But when your US ten-year yield is 0.7 per cent annually, or 0.26 per cent in UK, -0.46 per cent in Germany, your starting position is so skewed, as is its ability to generate its portion of returns.”

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