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Global equities have continued to rise strongly this year with YTD returns pencilled in at 13.47%*. Using the Enterprise Value/Cashflow (EV/CF) multiple, global equities have not been this highly valued since the dot-com boom in the early 2000s. Furthermore, as Chart 1 shows this is no longer just the case in the US, as European equities are now almost as highly valued.
*Source: MSCI World, Datastream, data as at 31.08.2017 and in USD. Equity indices quoted on the basis of net dividend reinvested.
Why do we use EV/CF as a valuation multiple as opposed to the more universal Price Earnings (PE) ratio? In short, because we think the reliance of PE on the income statement provides only one side of the story, and earnings are one of the easiest figures to massage through creative accounting, buybacks, and capital structure. In our view, using an enterprise-based and cash flow approach provides a fuller picture.
As Chart 2 shows, 'high growth' stocks have driven this year's equity rally, especially those in the technology space. Meanwhile, ‘steady growth (compounders)’ - what we call defensive stocks - have underperformed.
2017 YTD
Source: MSCI World, Datastream, data as at 31.08.2017 and in USD. Equity indices quoted on the basis of net dividend reinvested.
Source: MSCI World, Datastream, data as at 31.08.2017 and in USD. Equity indices quoted on the basis of net dividend reinvested.
While the current environment is perhaps more favourable for growth strategies, long-term track records show such an environment tends to be rather short-lived. As chart 4 shows, over the longer term it is the less glamourous, lower growth, defensive US stocks that have outperformed. A similar, actually more emphatic, trend is observable within global equities over this same period. This is because, more often than not, growth stories do not translate into sustainable shareholder returns.
1987-2017 YTD
Source: MSCI World, Datastream, data as at 31.08.2017 and in USD. Equity indices quoted on the basis of net dividend reinvested.
We think this calls for great caution when investing in growth stocks, especially when valuations are not supportive.
Although the aggregate market is very expensive, we continue to find interesting opportunities in defensive steady-growth stocks in our portfolios. As stated above, these have the advantage of being less expensive and we believe should outperform over the long term.
To find out more about how we manage the Pictet Global Defensive Equities strategy, read below or get in touch with your Pictet salesperson.
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