Overview
The MSCI World Index (ex-Aust) in local currency terms returned 4.23% over the quarter ending 31 March 2015.
MSCI World (ex-Aust) Index (local currency)
Outlook
Low global interest rates have forced investors to abandon low yielding cash investments as a source of income and seek riskier assets that generate higher rates of return, principally shares. This phenomenon has been wide spread and has been a key driver of global sharemarkets over the last few years.
Unfortunately, chasing higher yield can sometimes come at the expense of ignoring the underlying fundamentals. The United States is a good example, where despite the strength of the economy, valuation metrics are stretched. Investor over-exuberance has caused implied valuations (as reflected in current share prices) to run well ahead of forecast corporate earnings. Periods of over valuation are not uncommon but increase the downside risk if earnings disappoint or the outlook deteriorates.
In Europe, the upswing in business activity over recent months is gathering momentum, which augurs well for corporate profits, particularly as they are coming off a relatively low base. Although European markets are already factoring in part of this growth, we believe further upside remains should the recovery continue.
In Japan, despite recurrent economic weakness, monetary easing plus the Government Pension Investment Fund's increased allocation to equities should continue to support share prices.
Valuations in Emerging Markets are mixed. Markets exposed to the downturn in China appear reasonable value but this assumes China manages to avoid a hard landing and commodity prices soon recover.
Conclusion
On balance we believe global sharemarkets are overvalued, particularly in the United States. Nevertheless we are not necessarily expecting any sharp correction as financial and economic conditions remain broadly supportive. In the absence of value though, it remains appropriate to gradually decrease exposure to this asset class into the current strength.
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