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US equity market world's most expensive, says Schroders

Glenn Freeman  |  16 May 2019Text size  Decrease  Increase  |  
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The US equity market is the most overpriced on the planet and investors are better off considering opportunities in European financials and to a lesser extent Australian banks. 

That is the stark view of Schroders portfolio managers Nick Kirrage and Andrew Fleming.
Kirrage is co-portfolio manager of Schroders Global Recovery Fund – so named for its aim to spot undervalued companies with long-term earnings potential, while Fleming oversees the manager's Australian equities portfolio.

European banks Standard Chartered, Barclays and Royal Bank of Scotland rank within the top 10 holdings of the Schroders' Global Recovery Fund. Kirrage told an adviser forum last week that they remain among the most discounted stocks.

He said that since the 2008 global financial crisis, many global banks have been considerably more careful at managing their debt levels and risk exposure than companies within other sectors.

"Banks represent around 20 per cent of our portfolio, and these are among the cheapest stocks in the world,” Kirrage said.

"But most compelling, they are one of the few sectors that has been de-risking every year since the last crisis.”

Resources companies such as Australia’s South32 (ASX: S32), Italian oil major Eni, and Russian oil producer Lukoil also figure among the Global Recovery Fund’s top 20 holdings.

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The fund also holds positions in consumer staples and global healthcare names such as French pharmaceutical giant Sanofi, which Kirrage sees as appealing, providing investors have the patience to buy into them at reasonable prices.

"People often say 'these are great businesses, but you'll never get a chance to buy them'.

"I bought consumer staples in 2003, I bought healthcare in 2011… patience these days is measured in quarters, but if you can make it stretch into years, you can genuinely buy good businesses."

In contrast to the good buying opportunities he sees in European banks, Kirrage notes the fund is underweight in US equities, which he sees as overpriced.

"In terms of underweight positions, there's only one story: welcome to the US being the most expensive stock market on the planet.

"It's only been this expensive once in history, and that was the tech bubble – and that didn't end very well," Kirrage said, referring to the calamitous falls in the “dotcom” sector between 2000 and 2002.

Big 4 still appeal after royal commission

Kirrage’s colleague Fleming told the forum he still expected Australian banks to deliver attractive returns despite the fallout from the banking royal commission.

Banks endured a torrid 2018 after several damning revelations, including fees for no service as well as accounts of dead people being charged fees.

Bank profits have since suffered as regulatory and remediation costs bite - Commonwealth Bank alone has paid out more than $2 billion in reparations - but Fleming remains upbeat on their overall earnings potential and returns on offer to investors.

"Even though there is bad news to come with some of the sectors like banks – everybody knows bank earnings are dropping and it is impossible to make the case that in five years' time they'll be making more money than they are today,” Fleming said.

"But if your starting point is returns of 10.5 per cent and they drop by one-third, you're left with 7 per cent, or roughly three to four times what you're getting from several other sectors," Fleming said.

Other sectors that appeal to Fleming include commercial services and consumer discretionary, including names such as Telstra (ASX: TLS), News Corporation (ASX: NWS), and Harvey Norman (ASX: HVN).

On the flipside, Fleming is less enthusiastic about some other big names such as biomedical company CSL (ASX: CSL) chiefly because he fears it is overvalued.

"CSL is a magnificent company, but that doesn't mean they're a great investment. There's a very big difference between a great company and a great investment," Fleming said.

"We're not that focused on the spot PE or earnings, but on what can sustainably generate yield in excess of benchmark returns."

is senior editor for Morningstar Australia

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