It may still be a ‘risk-on’ investment environment but only just. Next year and the year after are looking “softer”, according to State Street Global Advisors’ active quant managers. The risks which emerged at the end of last year are now more obvious.
Olivia Engel, SSGA’s Boston-based global CIO for active quantitative equities, and Kevin Anderson, the Hong Kong-based head of investments for Asia Pacific, provided a media briefing in Sydney last week. The picture they painted was not particularly rosy.
Engel, who was promoted to her role from Sydney last year, said the valuations were looking “elevated” in the US but it was still “not too difficult” to find undervalued stocks. “We are sitting on around two times book value and that’s fine by me,” she said.
In the technology sector, though, margins had grown from 13 per cent to about 20 per cent in the past 10 years. “It can’t get much better than that,” she said. SSGA does not own any of the FANGs (Facebook, Amazon, Netflix and Google) or their Chinese equivalents, the BATs (Baidu, Alibaba and Tencent), in the discretionary active equities portfolios.
Like most quant managers, SSGA has a value bent with a momentum kicker. Engel said that growth stocks tended to be very sensitive to economic conditions and they also tended to disappoint over the very long term. “As interest rates rise and earnings start to slow you need to temper tour expectations for growth companies,” she said.
In terms of opportunities, what it meant to be “defensive” was changing. For instance, the firm has been increasing its exposure to financials – but not the Australian banks – because of the risk that both inflation and interest rates might rise more quickly than expected. Similarly, it has been reducing its exposures to health care and utilities.
In the emerging markets, SSGA favours Asia, including “parts” of China, over Latin America. The firm has an emerging markets small-cap fund that has performed very well in recent years but which has reached capacity.
Kevin Anderson said that with Brazil and Russia being removed from the likely recession list, emerging markets as a whole should grow at roughly 6 per cent compared with the developed markets’ 2.5 per cent. Australia would be about 2 per cent.
“We don’t think inflation will be a problem,” he said. “We talk about inflation being under control but some of the statistics could make you question that. For instance, employment is strong but as we get closer to full employment [in the US] wage inflation is not responding. For the first time in 20-25 years there are more job openings than there are people to fill them. So, labour is an issue, not just in the US, but also in Japan especially. Japanese growth is looking OK but there are 159 openings for every 100 potential employees.
With respect to China, Anderson said that SSGA expected an “orderly review” of its indebtedness. There was a debt-for-equity swap program, although this was not a healthy way to solve a debt problem because the issue tended to kick back in down the road. He also believed that China would be the bigger loser in a trade war with the US. He added that he thought “cooler heads will prevail” before the US mid-term elections.
Greg Bright is publisher of Investor Strategy News (Australia)