The Morningstar quarterly view of asset classes, published last week, emphasises the over-valuation of most equities and bond markets, including Australia’s. Despite a few minor pockets of value, the big research house has gone longer to cash in its own recommendations.
The quarterly ‘economic briefing’ says that, although key equity asset classes recorded losses over the last quarter, sharemarkets remain overvalued, raising the prospect of further losses from these levels.
“In terms of regions, we retain a relative preference to emerging markets, the UK and Japan, followed by Europe. US equities remain the least attractive region, with US shares continuing to trade well ahead of our fair value estimates,” the report says.
An exception to this is the US healthcare sector, which has been plagued by uncertainty over the outlook for healthcare regulation and is attractively priced, Morningstar says.
“With broad-based global equity markets generally considered expensive, we continue to search for more tailored investment opportunities in countries and sectors that offer us a superior reward for risk. With this in mind, we remain positive about European energy securities, European financials, US healthcare and European telecommunications, including names such as Telefonica, BT, Vodafone, Orange and Swisscom.
“The underperformance of UK equities versus regional peers since the start of 2017 has increased the relative appeal of the UK market, with several high-quality businesses across the energy, healthcare and telecommunications sectors standing out as particularly attractive.”
As for Australia, Morningstar’s outlook says that, notwithstanding the decline in the Australian index in the March quarter, “we continue to regard Australian equities as overvalued and the two largest sectors, financials and materials, as generally unattractive”.
Regulatory risk remains – with the steady stream of headlines from the Royal Commission into banking activities the latest factor to contribute to an uncertain outlook, the report says. “In our view, the big four banks remain far from compelling value in aggregate. This is particularly true relative to global peers, which generally offer better value, although this has diminished in recent times. With this, we continue to see better opportunities in other financials, notably in select insurers. We further struggle to see attractive valuations within the materials sector, as we typically view these companies to be of lower quality, that is, having no ‘economic moat’.
“While the resource sector’s performance was mixed in the quarter, our view remains that most companies within the sector are still trading well above our estimates of fair value. As such, the two key sectors (financials and materials) in the Australian market continue to offer a less attractive reward for risk.
“Investors in this market will need to be increasingly nimble to take advantage of valuation opportunities as they emerge (and avoid those assets that are expensive), in order to deliver superior risk adjusted returns. This involves applying a diligent investment process and an open mindset to moving away from an index-like exposure. We remain underweight Australian equities with more attractive opportunities available in other asset classes.”
Morningstar is sitting on 27 per cent cash, for its balanced portfolio recommendations, against a strategic asset allocation of 20 per cent. Notwithstanding its views on valuations, the firm remains overweight to international equities, boosted by an emerging markets exposure.