All this week, Morningstar.co.uk will be bringing you a Guide to Investment Ideas for 2017; stock picks, market reactions and political forecasts from the investment professionals.
A lot of effort is spent by the financial community attempting to understand equities at a country or regional level, however what most investors don’t appreciate is the attribution from sector exposure. For example, the U.S. has been one of the strongest market performers over the past 10 years and Italy one of the worst. It is easy to create a story about the pros of the U.S. and the cons of Italy, however a large contributor towards the performance differential is the underlying sector exposures.
For example, U.S. equities have a structurally high exposure to technology of 21%, whilst Italy has a negligible exposure. In fact, Italy is structurally more exposed to financials and energy, accounting for 56% of its total market cap, only slightly behind Russia with 75% exposure. As a comparison, U.S. energy and financials only account for 24% of the total market cap.
It should therefore come as no surprise that technology has been one of the strongest performers over the past 10 years, up approximately 8% per year, whilst energy and financials are some of the worst, 2% and -1% per year respectively. For this reason, anyone attempting to selectively position international exposures must be able to take a long-term view of the sector fundamentals.
A look at the evolution of the sector valuation-implied returns clarifies that energy and financials were favoured holdings through 2016. However, these expectations have tempered in recent times following the strong rally in prices. This is exactly what we expect to see in the long-term. As investors begin to understand the fundamental attraction of an asset, they buy it up until the price hit equilibrium or continue into overvalued territory.
Therefore, the simple strategy in a multi-asset approach is to buy cheap assets and ignore the expensive ones.
On this basis, telecommunications now have the highest return profile over the next 10 years and is the only sector with greater than 5% per annum returns. Energy, financials and healthcare are also reasonably attractive. At the other end, consumer discretionary stocks remain the most overvalued and could be expected to deliver a negative return according to our analysis. Industrials, technology and materials are also unexciting.
Defensives versus Cyclicals
If we think about long-term investing in the realms of sport, it would be hard to pass the concept of a marathon versus a sprint.
Using this analogy, there is a famous saying that slow and steady wins the race. The same applies when investing, as can be seen by assessing the long-term dividend growth grouped by economic sensitivity.
