Are equity markets overvalued?

By Tony Cousins and Doug Nicol

The Global Cautious fund is a cautious growth vehicle that sets out to deliver a cash plus return and provide investors with significant capital preservation.

Here is a breakdown of their performance over the year:

Over the course of 2020, the fund delivered an impressive 3.3% net return and had one of the lowest drawdowns compared to its local and global peer group during the first quarter of 2020, when markets slumped

Pyrford International ("Pyrford") are the appointed Global Best of Breed™ manager of the fund, who implement a multi-asset strategy to construct and manage the portfolio. They have been running this strategy for 24-years and have achieved a positive return in each of these years, demonstrating a tremendous track record of preserving investor capital.

At the start of 2020, equity markets prices were trading at a level of 21 times market earnings (PE ratio).

This was mirrored in the dividend yield for global markets, which were around 2.3% on the MSCI World Index.

As the crisis unfolded in 2nd half of March 2020, markets fell sharply, and valuation levels improved. PE’s fell to about 15-16 times and dividend yields improved to close to 3%. Pyrford responded by increasing the equity weighting from 25% to 30%.

Equities recovered thereafter, despite the negative economic effects of Covid and lockdowns. Pyrford saw strong upward movements in equity prices to the extent that by June those better valuations had evaporated. The team decided to take the profits on the additional equity exposure and reduced the equity weighting back down to 25%. The equity weighting of the portfolio is shown in the chart below:

Reducing Equity Weights in 2021
Since June 2020, equities have risen sharply and the earnings base for those equities has declined sharply. The PE ratio on the markets has risen markedly since that point, approaching 29 times earnings. Pyrford are concerned about equity market valuations at these levels as significant earnings growth is being forecast. Their view is that equity market are vulnerable at current prices, and have decided reduce the equity weight again in January 2021 to 20% of the total fund.

Current Positioning
The fund aims to achieve a cash plus 3% return over rolling 3-years, with significant downside protection. To achieve this objective, Pyrford have adopted a defensive position on the fund and continue to follow a targeted value and quality driven strategy. The fund has 77% in bonds (32% US and 35% non-US), 20% in equities (8% US and 12% non-US) and 3% in cash. In terms of unhedged overseas currency exposure, we are on a fully hedged basis at 44.1%.