Equities were battered in March, but have rebounded to levels that almost exceed where they were before coronavirus struck. This has led some investors to question whether the asset class now looks expensive given the extreme economic uncertainty that threatens the earnings of many companies.
Timothy Woodhouse, manager of the JP Morgan Global Growth & Income trust, said that because the equity risk premium looks elevated versus history, it suggests that stocks, on a long-term basis, remain cheap.
“I think the rebound has been very impressive,” he said. “What happens when you plunge into a recession and come out of it, short-term multiples do start to look stretched.
“This is because earnings collapse and the markets move in advance of earnings recovery.”
The manager of the £495.6m global equity investment trust, warned investors against focusing too much on short-term multiples.
“When you look two and three years out, they don’t look especially cheap anymore, but I think you have another dynamic at play, which is the action from central banks and governments around the world,” he said.
“If you look at things with an equity risk premium hat on, looking at the yield on equities minus the Treasury yield, or whatever you choose the risk-free rate to be, stocks do look cheap on a long-term basis”.
He explained that when interest rates are low, mathematically it implies that near term multiples should be higher.
Performance of equity indices YTD
Source: FE Analytics
Woodhouse said that with rates being so low, and in the US with asset allocators talking about negative rates, he could not see how a long bull market in bonds can continue going forward.
Therefore, he said, pension funds will have to switch more of their allocation to equities in order to continue to generate the returns that they need.
“We’ve seen some large pension funds in the US starting to talk more about putting more leverage into some of their funds to generate some of the returns they need,” he said. “I think that does speak to people having to really reach.
“If you are a large asset allocator, a pension fund for example, and you’re looking to generate significant returns, well equities is probably the place you have to continue to allocate more and more money to, and that is a longer term tailwind.
“That tells you that the asset classes that offer better returns, will continue to see flows over the coming years,” he added.
However, Woodhouse admitted that with the equity risk premium, investors do have to take a longer-term view on rates.
But he said if one were to ignore what Federal Reserve chair Jerome Powell and the Federal Open Market Committee has indicated, and look beyond 2022, “it's still very hard to see what the sources of inflation would be that would lead them to have to raise rates”.
He argued that the continued progress of technology has been deflationary for the past decade and there is reason to believe that will continue.
“We are going to see jobs replaced by automation, by software, and we are going to see technology find ways to make us more efficient,” he explained. “That does bring deflationary pressure.
He said over the long term, especially when considering demographics, he still sees inflation remaining low and therefore rates remaining low around the world.”
The manager conceded that the market clearly is pricing in something akin to a V-shaped recovery.
“That could still happen, there are a lot of variables at play, but I think the risks in the very short term are probably slightly more to the downside,” Woodhouse said.
Nevertheless, he said it is very important for investors to stay invested, because trading in and out of the market risks missing the very best days.
“There is data out there that suggests over the course of the past decade if you missed the best 20 days, your returns would have been pretty much halved over that decade,” he explained. “And those times are predictably often when there is a lot of volatility and a lot of controversy.”
The JP Morgan Global Growth & Income trust’s top three holdings are Microsoft, Amazon and Alphabet, US technology companies typically held by global growth funds. Woodhouse said one of the unique things about the global equity income trust was its holdings in these types of companies.
“We completely understand the requirements of shareholders and their desire for capital, but we think it would be detrimental if we were forced to buy things like European banks or large-cap energy companies where we have real questions over the structural outlook, but are forced into holding them simply because of the yield,” he said.
“That would mean you couldn't own things like Amazon where the opportunity ahead of them is incredibly significant.”
And the manager has also taken the opportunity to add some names to the trust during the sell-off in March with NXP Semiconductors, Adidas and American Express.
He said that at any point in time the underlying portfolio will provide between a third and half of the roughly 4 per cent yield, the rest being paid out of reserves.
“We can continue to do that even if there were no NAV growth, for well over 20 years,” he added. “We are looking for the best companies that we can find around the world based on the in-depth fundamental research that we do, and we have a vehicle from which to take advantage of those, but also to generate and pay a very good dividend to our shareholders.”
Performance of trust vs sector & benchmark under manager
Source: FE Analytics
During Woodhouse’s tenure since September 2017, the JP Morgan Global Growth & Income trust has delivered a total return of 20.06 per cent versus 22.56 per cent from the MSCI AC World index and 7.169 per cent from the six-strong IT Global Equity Income sector.
It is currently yielding 3.94 per cent, has ongoing charges of 0.57 per cent, is -0.4 per cent geared, and is trading at a premium to net asset value (NAV) of 2.8 per cent as at 29 June.