The case for cheap offshore equity valuations – and corresponding opportunities for strong long-term returns – is becoming weaker by the day.
Philipp Wörz, PSG Asset Management
Global equities have been in a bull market ever since the 2007-2008 financial crisis. With both the MSCI World Index and the S&P 500 trading at over 20 times earnings, they are well above long-term averages. Positive sentiment and strong returns in offshore markets may act as a lure for wary South African investors. But the case for cheap offshore equity valuations – and corresponding opportunities for strong long-term returns – is becoming weaker by the day.
Low valuations and conditions of fear usually create the best opportunities for long-term investments
This improves the chances of finding potential ‘bargains’: quality companies trading at discounts due to general market pessimism. Yet most market participants repeatedly expose themselves to equities (and other risk assets) when visibility about the future is relatively clear and sentiment is strong, with little regard for valuations.
Currently, levels of investor complacency and market valuations are high. This is best illustrated by the Chicago Board Options Exchange Volatility Index (widely known as the VIX), which reflects expectations of the future volatility of the S&P 500 – and therefore gives an indication of fear or complacency in the market. When the VIX is low, investors expect stability (and vice-versa). Recently, the VIX, which has been in existence since 1990, hit an all-time low.
A different view on risk – and South Africa as an investment destination
A textbook explanation of risk may lead you to believe that share price volatility makes stocks risky. However, risk should really be defined as the potential for permanent capital loss. As such, be careful about moving assets offshore indiscriminately, a trend that is visible in the current market.
Many ordinary South Africans and other market participants are fearful and uncertain of the local economic outlook, and have ‘rushed for the exit door’ to invest money offshore. While this may feel like a safer option, the reality is that current fear and uncertainty are creating an environment for attractive long-term investment returns.
That being said, there are still attractive opportunities to be found across the globe despite the rise in overall market valuations. In many cases, these opportunities will not leave the average investor feeling ‘warm and fuzzy’ – many of them are in unloved parts of the market that offer a greater chance of mispricing. In addition to emerging markets such as South Africa, there are great opportunities in areas such as agricultural commodities, US retail and UK domestic industrials.
The attractiveness of cash
Against a backdrop of high valuations and low levels of fear, cash is often an attractive asset class as it provides firepower when market sentiment and valuations mean-revert (move back to average levels). Accordingly, cash levels in the PSG Global Flexible Fund increased to roughly 30% of the fund over the past 12 months. In addition, although the average P/E ratio of the holdings in the fund has crept up slightly to 15.5 times, the earnings of these companies are still relatively low and provide good scope for growth.
Philipp is the Co-Fund Manager of the PSG Global Equity and Global Flexible Feeder Funds and the PSG Global Equity and Global Flexible Sub-Funds