Background analysis: In the past six years, the shares have known only one way and it has been up. As a result, wealth management investors have reaped solid returns, but can it continue?
For many years, wealth management’s balanced portfolios have been fully allocated to shares within the current investment framework. This has been extremely attractive, but with strong markets, one should sometimes stop and evaluate as an investor. Has the recent quarters’ events changed the formuepleje’s basic view of equities, and how do you as an investor relate to shares in the coming quarters?
Attractive valuation and an active US central bank have since 2011 been some of the most important reasons for a maximum share allocation in the Property Management Associations’ portfolio. And over the past few years, the expectation of a demand-driven and investment-driven recovery has been the primary reason not to change the current stock allocation.
This decision has been dominated by the United States, which is crucial for the development of the global stock market. But regions like Japan and most recently Europe have copied the US model and currently support the respective economies with the same type of massive monetary stimuli. Measures aimed at supporting asset prices and increasing inflation expectations – quite as it has been in the US.
American economy improving
When we focus our focus on US equities, there are a number of factors that have changed over the past few years. US stocks are no longer cheap, the economy and macroeconomic developments signal a self-sustaining US recovery that is slowly gaining momentum. Precisely the gradual improvement in the US economy is the main scenario behind Formuepleje’s continued full exposure to equities. The level and development of a number of key parameters contribute to supporting this view.
The labor market
Although the degree of unemployment is a backward or historical observation, it also has considerable forward-looking economic impact through, among other things, the confidence indicators. The trend in US unemployment is shown in the graph below. The effect of the financial crisis is evident around 2008 and 2009, when the level of unemployment rose from 4.5 to 10.0 per cent. Subsequently, the level has fallen steadily, and today the unemployment rate is 5.4 per cent.
Thus, the number of unemployed is barely halved, and this is one of the most important parameters in the interpretation of economic development. The development means that the purchasing power of the population has all the same been increasing, although the composition of the workforce has changed.
Despite a declining unemployment rate, this has not resulted in actual wage inflation. However, observations show a tendency towards rising rising labor costs, which is also one of the main reasons why the US Central Bank is expected to raise interest rates during the second half of 2015. Employment is crucial for increasing economic activity and accelerating. increases, and wage inflation begins to come.
Another way of assessing the economic condition is to look at developments in US housing prices. After a sharp price adjustment in the housing market, we have seen a positive price development since 2012.
Just as falling unemployment has a positive income effect for the unemployed who come to work, rising property prices have a positive wealth effect for homeowners. Increasing economic confidence as well as increasing wealth effects from, among other things, the property market, the stock market and employment are important parameters in the sustainability and potential of the continued positive economic development.
Indicators such as unemployment and house price developments are historical measurements, which, as I said, have a great influence on the confidence indicators that underlie the consumption pattern.
The figure below shows the trend in US consumer confidence and captures many of the positive trends recorded in the historical economic variables. It produces an American consumer who has been in progress since 2011. This progress is crucial for the US economy to maintain and increase the current economic momentum in the future. Without an optimistic American consumer, it is difficult to see a positive development in the underlying demand parameters and thus ultimately the stock market.
Business revenue and earnings
A unifying figure that expresses these economic variables could be the development of the US gross domestic product (GDP). However, in relation to the stock market, the trend in revenue and earnings seems to be more significant, as it is precisely over a long period of time that the earnings of the companies are the basis for the share development.
While the development in revenue has, of course, been adversely affected by the financial crisis around 2008 and 2009, the development for precisely revenue has been less volatile than for earnings, while revenue over the last few quarters shows limited momentum. Earnings, on the other hand, were hit relatively proportionately by both declining revenue and a strong stock adjustment in the companies following the financial crisis. Since then, cost savings and efficiency improvements have significantly increased growth compared to revenue.
Due to these cost adjustments and efficiency improvements, the US companies today have record high profit margins, where the potential for further improvements, all else being equal, is considered to be limited. This does not mean that US companies do not continue to streamline, but instead the earnings-positive effect that has been recorded from lower costs does not come back to the same extent as before. Revenue is deducted from macroeconomic variables such as the labor and real estate market and must, to a greater extent, reduce earnings in the future.
Therefore, the equity portion must be maintained
Going forward, the Fortune Management’s belief is that the operational recovery that is gradually coming into the US economy will increase in strength and support the background for the current equity exposure. The US development has been challenged by the extraordinarily cold winter in the first quarter and a sharp fall in oil prices since the summer of 2014, which has put pressure on the energy sector’s investment activity. Therefore, if these one-off effects are corrected, the overall position remains that the US economy is moving in the right direction, drawn by, among other things, the labor market and increasingly the companies’ investment activity.
One of the greatest current fixes for US markets – and for that matter global ones – is the time and strength of the first US rate hike for over ten years. The US Federal Reserve’s decision to initiate interest rate hikes at some point is based on the growing economic momentum and the increased expectations of rising inflation. Interest rate hikes have historically created volatility and uncertainty in the stock markets, but overall, an interest rate hike should be used as a confirmation of the positive economic activity more than an attempt to destroy the shareholding (read more in the article “Has your share portfolio got the trunks?” In the magazine FORMUE) 02 // 2015).
As an investor, however, one must be aware that the return generation in the stock market going forward – also as a result of the American Central Bank – will change from what we have been used to. In the past, the stock market in the US has been particularly drawn from the expectation of better times in the wake of monetary policy measures, which has resulted in a more expensive stock market measured by earnings. Going forward, it will to a greater extent be the realities that must draw the development and define the return potential. Therefore, as a stock investor, one should also adjust to lower returns if compared with the period after 2009 (read more in the article “American regime change in the stock markets” in the magazine FORMUE 01 // 2015).
Keep an eye on declining growth
A major risk factor for the US and global economy is a real slowdown in growth. Uncertainty about the strength and durability of the US recovery is a factor that could trigger a significant drop in share prices. The background for the risk element arises, among other things, from the American companies.
Since 2008-2009, US companies have adapted to the stock situation, the cost base and continuously streamlined their efforts to create earnings growth despite the level change in revenue. A mission that must be said to have succeeded, as earnings have grown significantly more than revenue in the same period.
Should a financial slowdown occur, it will directly impact on the companies’ earnings, which is precisely the primary driver for the share price development over time. Because of, among other things, a historically high profit margin, which leaves limited space for further improvements, the companies do not have the same opportunities to adjust costs and streamline as before. Property management relies constructively on the risk scenarios and will try to minimize any negative effects. However, it is worth emphasizing that the main scenario remains that economic momentum in the United States will support global equities and thus the main reason for full allocation to equities within the Investment Funds’ investment framework.