Traditional asset valuation metrics will rise to the fore again as the market cycle turns into a familiar phase but with a different twist, according to MFS chief investment strategist, Robert Almeida.
In a presentation to the Morningstar Australia conference earlier this month, Almeida said that “investing is simple but hard” where factors such as cash flows, margins and valuation ultimately determine outcomes.
But traditional market signals have been weak since the global financial crisis against a backdrop dominated by the white noise of central bank intervention.
He said the distortion of post-GFC monetary policy has blunted the core purpose of financial markets “to price risk and allocate society’s scarce resources”.
For example, the Federal Reserve balance sheet now represents almost 80 per cent of US gross domestic product (GDP) with the comparable European Central Bank (ECB) figure only slightly lower.
While monetary authorities are currently trying to back-track, the latest central bank balance sheet ratio to GDP is about 16-times higher than just prior to the GFC in 2007.
Admittedly, the Fed had reduced its balance sheet to 40 per cent of GDP by early 2020 from a high of 50 per cent (the ECB was going the other way) before the COVID-19 crisis sparked a monetary loosening of historic proportion.
The free money distortion has also seen net income in developed markets deviate from about par with nominal GDP in 2009 to almost three-times higher by the end of 2021.
Almeida also pointed out the stock market valuations in 2021 were at an extreme well above the pre-GFC peak (but still under the technology bubble heights of the late 1990s).
At the same time, the share of companies on the broad Russell 2000 index losing money has climbed above levels last seen before both the 2000 ‘tech wreck’ and the GFC.
However, rising interest rates (now higher still since the Morningstar conference) have put long-forgotten valuation measures back on the table – dragging asset prices down as per expectations.
If the market cycle is now conforming to traditional value-based rules, though, investors should not expect an exact replica of previous episodes, Almeida said.
For example, this time around company margins are under pressure due to entrenched higher labour costs while technology has “changed things in multiples ways”.
“Society knows the impact of goods – not just where they were made, but how they were made and what they are made out of it. The democratization of information, particularly the power of social media, has created a new culture of ‘move fast and break things’,” he said. “Capital is no longer scarce. Investing, like information, has been democratized. Those have felt their voice was not heard – now has not only a voice through social media but a means via costless trading/investment platforms.”
Companies are also facing pressure to comply with new environmental, social and governance (ESG) standards from consumers, employees and investors in a trend that will further cut into corporate profits.
“Compliance is expense. ESG is not for free,” Almeida said. “For example, firms will have to monitor beyond first- or even second-tier suppliers. In cases which a significant portion of workers/suppliers operate in markets associated with human rights abuses, compliance will necessitate either relocation to less-desirable places or the bifurcation of supply chains. Noncompliance will be costly.”
The Boston-based MFS has about US$700 billion under management including a number of significant mandates in NZ – notably with the country’s largest private fund manager, ANZ Investments. Clarity Funds Management, part of the Investor Services Group, also offers an MFS fund in portfolio investment entity (PIE) format.