Fifteen weeks after the start of year 2000, most major equity markets had negative performances in local currencies. However, nothing had really changed for a vast majority of these companies/in terms of their medium term growth prospects or earnings forecasts. Besides, on the macro economic front, world economic growth has not been questioned by economists and 2000 is considered to be a year of sustained economic growth.
Against this background, March and April’s equity market’s turmoil was hence probably and mostly linked to market valuation problems. These problems had mainly emerged following the rapid rise of TMT stocks in the last quarter of 1999 and the first months of year 2000. Divergences between markets in terms of performances (ie Dow Jones versus Nasdaq), weak market breadth (less and less stocks were accountable for indices performances), the opposition between stocks of the so called ‘old’ and ‘new’ economy, and the huge number of overwhelmingly successful IPOs, were probably some of the signs pointing towards the disappearance of a certain rationalism in market valuation or investor’s behaviour. At this point, equity markets became very fragile and nervous. They only needed a trigger to come back to reality. No matter what this trigger was, quite a large part of the market exuberance was probably corrected during the rough time, which had followed.
In the case of the high growing sectors or markets, the adjustments were impressive but they are, however, still trading at high relative ratios. As for the blue chips – or for the more traditional sectors – the overall valuations were not excessive before this crisis and are today offering good value.
We believe these conditions are moderately bullish for the medium term (second part of the year) but do not support a maximum exposure to global equities. We recommend Swiss clients have a moderate global overweight in equities of +15%. With a 40% global allocation to Swiss and international equities, this +15% overweight (neutral is 25%) lies more or less in the middle of the range for authorised potential overweight (maximum is 50%).
From a very tactical point of view, and to take profit from recent attractive valuations in many sectors, we would even consider increasing this global exposure by 5%. This new equity allocation would be realised through purchases of large capitalisation stocks in both high growing and more traditional sectors.
Generally speaking, we recommend active deviations to be balanced, at least during the early stage of the equity market rebound. International equities have an equal weight (21%) in our asset allocation compared to domestic equities (20.5%). But in terms of active weights, most of the overweight is on international equities (+10%). As far as fixed income placements are concerned, we expect rates to remain somewhat stable with very limited prospects for capital gains. Clearly, our allocation reflects our decision to concentrate our active ‘bets’ on equities.
The defensive nature of the Swiss market is appreciated in these times of great uncertainty, and we feel rather comfortable with our current asset allocation to our domestic market (+5% overweight). In terms of sector allocation in Switzerland, we consider that large capitalisation stocks (financial, health care and food) will mostly underperform the index over the medium term and expect the outperformance to come from smaller and medium stocks. Consequently, our weighting is neutral on the four major sectors of the index.
As for international equities, we expect most of the future added value to come from international sectors with high earnings growth potentials. Recent price declines have offered attractive relative valuation in technology and telecommunications stocks. We believe that the leaders in these fields should continue to deliver high earnings growth in the future. Hence, we have a global overweight in these sectors (+4% in technology leaders and +1.5% telecom stocks). We also favour basic materials and energy stocks, which both have very attractive valuations compared to their earnings forecasts (+1.5% energy companies and +1.2% in basic materials stocks).
In terms of regional allocation, the international equity exposure is rather balanced with all regions being overweighed compared to their benchmark’s weights. While most of the global absolute overweight is on the US (+4%) and European (+3%) markets, Asia is favoured in relative terms versus the index.
Alain Freymond is head of balanced mandates, UBP Asset Management
in Geneva