T. Rowe Price's cautious view on equities

Corporate reforms in Japan and Korea are enough to pique the interest of global fund managers, but a royal commission into Australian banks hardly registers.

T. Rowe Price, custodian of over $1 trillion in assets globally, remains neutral on the Australian market, arguing an overheated real estate sector and exuberance in consumer staples are offsetting positive expansion in the mining sector.

"Capex investment is a strong story we see in Australia, especially in innovation in the mining sector," said Thomas Poullaouec, head of multi-asset solutions at T. Rowe Price at a media briefing in Sydney on Tuesday.

"And while we see positive corporate governance reforms in places like Japan, which will continue forwards and offer opportunity, a [royal] commission in Australia has not been a large issue for global investors and really is not on our radar."

A royal commission into the banking sector in Australia announced last week has prompted concern global investors might avoid local equities, unsettled at government intervention.

US caution

But T. Rowe Price sees US equities as the most unsettling asset class, arguing they are far too expensive and too sensitive to unexpected market shocks.

"We struggle to see much earnings upside for US equities, which are already the most expensive by far," said Mr Poullaouec.

"And the positive earnings growth expectations are elevated and we don't think they will be met. Additionally, they are prone to surprise as volatility has been low for so long."

The most popular way to value the stock market is based on projected earnings over the next year. By that measure, known as forward price-to-earnings, the S&P 500 is trading at a lofty multiple of 18.5. That's significantly higher than the long-term average of 12.8.

"We are also cautious on equities more broadly because US stocks make up 50 per cent of global indexes," said Mr Poullaouec.

"So we have favoured government bonds, which act as a diversifier, particularly those with a lower correlation with equities."

Volatility due for a bump

Extraordinary monetary policy and persistently low inflation have kept volatility levels at record lows. The dampener on volatility is compounded by well-telegraphed central bank activity and economic data largely reading in line with expectations.

"But volatility tends to be very calm until it's not, and then it spikes in a dramatic fashion," said Mr Poullaouec. "So from these levels, it might revert back to normal which would be a dramatic change."

Technology companies that have adequately repaired their balance sheets, reduced debt and freed up cashflows are attractive options for the global fund. It is also looking towards emerging market debt in countries that are undergoing genuine reform - such as Argentina, India and South Korea - though Mr Poullaouec is cautious.

"Yes, this emerging market government debt is attractive, but you need to be active in that index," he said, highlighting South Africa and Turkey as stories to avoid.

A sustained pick-up in global growth, a wind-down in monetary policy stimulus and a considered slowdown in Chinese growth remain the biggest themes for 2018, with the global asset manager pointing to a pick-up in innovation spend as a boon for Asian equities, including Australia.

"Markets are sensitive to the pace of China's slowdown, even though they are focusing more on quality of growth rather than quantity," said Mr Poullaouec.

"This is bad news for headline growth, but it is not traumatic news, not a hard landing."

This story T. Rowe Price's cautious view on equities first appeared on The Sydney Morning Herald.