by John Wyn-Evans
In October I said the strong equity returns of the last couple of years had been driven primarily by an upward shift in valuations – a rising Price Earnings ratio (PE).
This reflected both a reduction in investors’ perception of risk, and also anticipation of future recovery in economic output and corporate profits. It might also have been a function of the vast amounts of money created by Quantitative Easing (QE).
One of the reasons that the US performed so well last year was because it managed to combine earnings growth with a re-rating. Other markets, the UK and Europe included, also re-rated, but earnings in aggregate failed miserably to live up to expectations, so the indices lagged.
The one area not to join the re-rating party was Emerging Markets, where commodity-related weakness and fear of the withdrawal of liquidity as QE was tapered conspired to produce a third year of underperformance.
So where are we now?
Consensus earnings growth forecasts for 2014 compiled by Goldman Sachs suggest the following regional growth rates: US, +11.9 per cent; Europe, +12.9 per cent; Japan, +9.8 per cent; Asia ex-Japan, +11.8 per cent; Emerging Markets overall, +8.2 per cent; and The World, +10.9 per cent. Bloomberg has an earnings growth forecast of 10.7 per cent for the UK’s FTSE 100.
If we believe that many developed markets are now close to or slightly above their long-term averages on a one-year forward PE basis, then these earnings growth estimates give us a good starting point in assessing the potential for returns from equity portfolios this year.
If PEs stay much the same, investors will see markets rise in line with earnings and also receive their dividends. For example the current FTSE 100 yield is 3.6 per cent, suggesting a potential return of 14.3 per cent.
The initial salvo of results in 2014 could best be described as a mixed bag, which goes some way towards explaining the choppy performance of equity markets so far this year.
The reporting period will run well into March. Be prepared for increased volatility as analysts and investors digest the news.
- Sponsored column. John Wyn-Evans is head of investment strategy at Investec Wealth & Investment