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05 March 2024

Valuation of assets offer attractive buys in crisis

A finance professional reacts to market downturn as he looks at his computer at NYSE floor (GETTY IMAGES)

By Shuchita Kapur

With the recession taking a stronger hold on asset markets across the world and making a larger dent in 2008 than most analysts expected, valuations of some of the underlying asset classes are now looking more attractive than they have ever been in the past few years.

According to the UBS Global Outlook 2009 report sent to Emirates Business, this offers investment opportunities in certain asset classes that might have seen an over-correction, such as corporate bonds. Nevertheless, the message of the report is loud and clear – proceed with caution.

"The economic forecast for 2009 is bleak, but financial markets have also priced in a lot of bad news. Our asset allocation stance reflects a more uncertain outlook and the belief that we will not simply pick up where we left off when the economy begins to recover. Amid heightened uncertainty in 2009, we stress the importance of portfolio diversification and taking calculated risks as a means to achieve outperformance," said Alexander Kobler, Global Head of UBS' Wealth Management Research, and Walter Edelmann, Head of the bank's Global Investment Strategy in their study.

However, the authors remain pessimistic about the health of the global economy this year. "A vicious cycle has set in whereby 'gloom begets doom', which is feeding pessimism about the prospects for the world economy. This delicate state of affairs is reflected in the weakest performance by financial markets in decades, as well as a flood of individual and concerted government actions to stem the crisis.

"Despite the efforts of policymakers to restore confidence, we believe that the global economy will weaken further during 2009. If, as we expect, the downturn finally begins to reverse course in late 2009, it may still be undermined by a number of new risk factors," they said.

"Attractive valuations of certain assets must be weighed against the risks stemming from a global recession. We remain defensive overall but recommend increased exposure to corporate bonds," the report said.

"Yields on corporate bonds have risen to levels not seen in a generation and already reflect deep pessimism about the future of corporate defaults. We judge that the correction has gone too far, and we find that corporate bonds now offer attractive investment opportunities. In general, we think diversified investments in investment-grade and speculative-grade bonds should be able to earn above-average returns over the course of 2009," it said.

Although all major equity markets across the world witnessed steep corrections in 2008, wiping trillions of dollars in market capitalisations, analysts believe that economic uncertainty and fundamental weaknesses will restrict any upward correction at least in the first half of this year. "We see long-term value emerging after the sharp equity market sell-off, especially in several European markets. However, further weakness in equities cannot be ruled out, as we expect the economic downturn to trigger a cyclical contraction in corporate earnings," the report points out.

Nevertheless, there remain pockets of opportunities, the report highlighted. "Amid a sharp growth slowdown, we favour defensive sectors due to their more limited business-cycle risk. We expect the most stable earnings in the healthcare, consumer staples, and telecom sectors, and to a lesser extent in utilities. We also continue to expect large-caps to outperform small-caps at this stage of the economic and equity market cycles, especially considering their compelling valuation and advantages of relative earnings stability."

"The bank remains bearish on property and commodities in the near term. "Regarding commercial real estate and several commodity markets, we still see significant cyclical risks heading into 2009. Signs of economic stabilisation would likely enable global equities to outperform commodities and real estate."

The report, however, warns investors to not ignore these sectors for too long.

"At a later stage, we think real estate investments and commodities could benefit from a reflationary policy mix, but, before returning to that asset class, we would await evidence from macroeconomic indicators that growth is beginning to stabilise," the UBS report said.

A slower global growth bodes ill for emerging markets. While direct effects of the subprime meltdown and financial market turmoil on Japan have been relatively minor, the indirect impact has been substantial.

However, UBS analysts do not expect economic growth to collapse even in these difficult times. Emerging markets now account for over a third of global economic output and analysts maintain that emerging markets are more resilient than in the past, and that their income levels will continue to converge with those of developed economies throughout the global slowdown.

Despite that, UBS believes that it is too early to increase exposure to emerging market assets. "The sell-off in emerging market assets in 2008 will likely carry over into 2009. Within emerging market equities, we do not find the present valuation discount to global equities especially compelling. Moreover, we see considerable risk to future earnings that is not yet fully reflected in analysts' forecasts. Within emerging market bonds, we think investors should avoid sub-investment-grade sovereign issuers and should instead diversify among the highest-rated investment-grade issuers."

The report also warns that the global recession could get worse this year. "We estimate that global economic growth will slow substantially in 2009 to two per cent, based on purchasing power parity weights. This low growth rate and substantial contraction of output in much of the world is consistent with the definition of a global recession," it said.

Despite the revival of the US dollar in the second half of 2008, the report is not very hopeful of the prospects of a stronger dollar this year. "We are convinced that the US dollar's revival will be short-lived. We think that as soon as liquidity in financial markets is restored and the boost from a weaker euro is felt in Europe, the dollar will resume its depreciation path. There is a good chance that this will begin to unfold during 2009. Therefore, we forecast a renewed drop in the dollar versus its G10 trading partners."

The report construes that Europe is better positioned than the US to cope with the difficult period ahead

"On both sides of the North Atlantic, governments will likely approve a wide array of fiscal stimulus measures, with significant effects on economic fundamentals," said the report.