Despite being only one month in, 2020 has had a rocky start, with positives such as the signing of the phase one trade deal between the US and China being overshadowed by rising geopolitical risks in Iran and then growing fears regarding the impact of the coronavirus emanating out of China. There were signs in 2019 that global industrial production had bottomed, and fundamental data in China has shown improvement with both Chinese imports and new export orders ticking up recently. Given the uncertainties posed by the coronavirus, the improvements in Chinese data may be short-lived, however, we remain hopeful regarding the overall global growth outlook given the willingness of central banks to maintain liquidity in times of crisis. In Europe, Brexit finally took place on 31 January, and Britain now enters an 11-month transition period where it will need to strike a trade deal with the European Union. Eyes will also be on the US this year, with the presidential election taking place in November.
Geopolitics has been one of the largest drivers of the slump in global growth and corporate profits over the past year. Therefore, less stress could be a powerful catalyst for a cyclical revival, however, with the uncertainty surrounding the coronavirus, the prospect of growth headwinds for at least the first quarter of 2020 could see global markets weighed down in the near-term. Once there is a growing confidence that the epidemic is being contained, we would expect the market to recover. We remain of the view that the cheap valuations and extreme positioning of the market still has the potential for a violent rotation into the value end of the market once the bad news subsides.
The divergence in valuations between the defensive and low volatility parts of the market and value cyclical sectors remain at heightened levels. This relative valuation bubble between value/cyclical stocks versus low volatility/defensive stocks is at a level that even exceeds the dot.com valuations of the late 1990s. We believe this reflects concerns around global growth which has been exacerbated by geopolitical issues such as the US-China trade war and Brexit, as well as slowing global growth. In our view, the market’s concerns are overdone.
We remain positioned to take advantage of the global economy moving away from outright bearishness and risk-off, to a more moderate growth environment. The defensive bond-sensitive and quality names remain in “bubble” territory and would be expected to correct heavily when the market moves into more rational territory. The valuation divergence simply illustrated by the gap between high and low PE names remains extreme and thus there is significant further upside potential in the portfolio as and when market valuations correct to more appropriate levels.
Brad Potter, Head of Australian Equities – Nikko Asset Management
