International equities
Avoiding the value trap
The global economy was heavily impacted by the financial crisis in the December quarter. Poor third quarter company results negatively affected investor sentiment. Coordinated interest rate cuts from central banks and government guarantees on bank deposits did little to help. Deflation was a concern, with declining house prices and the US CPI falling 1.0% in October, its biggest monthly drop on record.
These events encouraged investors to turn to cash, driving the interest rate on US treasury bills to zero (and even negative at one stage). Government bond yields in the developed world fell to their lowest level for fifty years. Increased demand for liquidity led many hedge funds to reduce their debt levels to meet redemptions. Commodities fell sharply during the quarter, and the Australian dollar finished the quarter down 11% against the dollar. China announced a $586bn stimulus package, contradicting the expectation that its economy would grow by 8% for the year.
As at the end of 2008, this global recession looks likely to be the second deepest in postwar history. The de-coupling theory – that emerging markets could withstand a slowdown in developed markets – has proved to be untrue. Globalisation has caused the recession to spread quickly, undermining any cushion of support from abroad for the US economy or vice-versa.
A number of uncertainties remain. The extent of de-leveraging by lenders remains to be seen, and the need for further write-downs and provisioning will depend on how much further asset values decline, especially in real estate. Many central banks have eased monetary policy aggressively, but it is unclear whether and when such policies will gain traction. While there are recent signs of a revival in liquidity and money growth, monetary policy in many emerging market economies remains restrictive. The new Obama administration is considering a massive additional fiscal stimulus, spread between infrastructure outlays and tax cuts. The timing, size, and economic effectiveness of such policy actions are likely to remain unclear for a while.
Bottom-up expectations for sales, earnings, and margins have moderated substantially in recent months. As of September the consensus for global earnings for 2009 was a rise of nearly 12%. By December this had swung round to expect a decline of more than 11%. However, by sector – excluding resources – earnings are forecast to remain roughly flat, suggesting that expectations may still be too optimistic. The sustained sell-off in global markets means that equities have significantly declined in recent months.
The danger is that investors might fall into a ‘value trap’, buying seemingly cheap companies based on price to earnings multiples only to witness further earnings downgrades. Our approach is to seek out quality companies that can provide opportunities for long-term sustainable returns while limiting downside risk.
