WRITTEN BY INVESTMENT STRATEGIST AND PORTFOLIO MANAGER, HAROLD STRYDOM
Scenario modelling has formed part of Peregrine Wealth’s investment process for two decades, and it enables us to better understand potential market outcomes and construct robust portfolios. The Peregrine Wealth Investment team has a core or “High Conviction” scenario based on a three-year view, which is expressed as macro-economic and market assumptions, including economic growth, inflation, interest rates, price-earnings multiples, and credit spreads, to list a few. Based on these assumptions, our asset valuation models produce expected returns for various asset classes. This section is used to summarise our High Conviction view and the resulting asset signals.
Rising interest rates and tighter lending standards have a delayed impact on the global economy, that can be lengthy and unpredictable, and at present, economic indicators show a mixed picture. However, unless we believe that “this time is different”, another economic slowdown lies ahead. This will likely impact company earnings negatively.
Given current market conditions, the global economy is assumed to grow below capacity over the next year, with weak growth across developed markets as tighter monetary policy and lending standards take effect in the United States (US) and Europe, countered by stronger growth in emerging markets like China and India.
In markets, moderate corporate earnings growth is projected over the next three years according to the GDP-to-profit capture and earnings normalisation methodologies used in our modelling. Earnings are well above trend in developed markets following the post Covid fiscal-induced boom. Valuations (trailing price-earnings ratios) are fair to attractive in most regions, with the notable exception of the US, which drives global equity performance. Consequently, the valuation signal from global equity, including the US, is now firmly below neutral, while Europe and emerging markets sit above neutral. Enhanced cash is rated above neutral under our assumptions, while bonds are rated neutral overall. Investment grade credit expected returns are attractive, with above average spreads – but we must remember that historically, spreads widen sharply when recessions occur.
In line with the global economy, the United Kingdom (UK) is expected to experience weak growth over the next year. While headline inflation is falling, core inflation has remained sticky. The Bank of England is expected to raise interest rates further but is nearing the end of its hiking cycle. UK gilts have sold off year-to-date and along with UK corporate bonds, are fairly attractive. London listed companies are attractively valued (on a trailing price-earnings basis), but weak earnings growth is projected over the next three years.
The table below offers a summary of our Medium-Term Asset Class Valuation Signals based on our three-year High Conviction scenario.
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