As US equities approach the top of the market cycle, investors should look elsewhere for bottom-up opportunities, says Franklin Templeton.
In a note, Templeton Global Growth Fund portfolio manager Peter Wilmshurst said while Europe, Asia and Japan present the possibility of earnings upgrades, “the US market [is] more complex”.
“One of the biggest risks for markets would have to be US equities,” Mr Wilmshurst wrote.
“Earnings have also been strong during 2017 but multiples are highly elevated, meaning there are increasingly fewer opportunities.
“[US equities are] more than 50 per cent of the MSCI World Index, and where many people have more than half portfolios.
“The US has had a full market cycle, so while there are some positives in the earnings outlook, there is also less going forward.”
Mr Wilmshurst pointed to the opportunities that existed elsewhere, such as in Europe, Asia and Japan.
“Profits are still below where they were before the GFC,” he wrote.
“So, these markets still have relatively attractive multiples and the prospect for earnings upgrades.”
More broadly, economic growth was expected to be “supportive of profits” thanks to a number of synchronised factors.
“In many countries, monetary policy is still easing, fiscal policy is becoming supportive, unemployment is falling and economic growth is buoyant,” according to Mr Wilmshurst.
“Additionally, inflation is generally subdued, corporate profits healthy and asset prices firm.
“One of the positives for equity markets globally is that, while many economies are moving into a phase of rising central bank interest rates, it doesn’t seem this will happen quickly and thus unlikely to negatively impact earnings and therefore the equity market.”
This process had begun in the US and could potentially begin in Europe in late 2018-19.
However, “inflection points in any cycle” could be unpredictable, Mr Wilmhurst warned – “and this isn’t just any cycle”.
“The massive central bank stimulus required to recover from the global financial crisis has led to extreme conditions that heighten systemic risk,” he wrote.
“Central bank balance sheets have ballooned to unprecedented sizes, creating an inorganic liquidity backstop, the removal of which could threaten elevated asset prices.”
The Federal Reserve was set to “run down its balance sheet”, and while this would not be executed in an aggressive manner, the “unprecedented nature of this ‘normalisation’” warranted caution.
Mr Wilmshurst also pointed to other troubling factors, which included the “unusually high” amount of global sovereign debt levels and government budget deficits, signs usually associated with crisis periods but were now part of our day-to-day life that could see unforeseen inflation spikes.
“Populism and nationalism”, too, were pinpointed by the portfolio manager as geopolitical risks that could disrupt the smooth flow of trade and labour.
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