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Offshore markets are risky. Be cautious.

In the current environment, it may feel right to be investing all your money offshore. This view may also be supported by the data that global equities returned 17% p.a. over the last decade. However, currently, global equities are generally risky as they are expensive, and therefore, one needs to be careful with an offshore investment strategy.

Firstly, fundamentally, global equity valuations are stretched

S&P 500 P/E ratio

S&P 500 P/E ratio

Source: multpl.com

The S&P 500 comprises 60% of the global equity market and provides a good general proxy for offshore equities. Its long-term average P/E (price to earnings) is 16x, and currently, it is 25x (a higher price for the same level of earnings). A reversion back to its average over time is likely, which will most probably be driven by stagnant returns or lower share prices.

Low interest rates are supporting high valuations

These high P/E (price: earnings) multiples are being supported by abnormally low interest rates and abnormally high debt.

US ten-year bond yield (%)

 

The issue is, when the global economy slows (which has started) there is very little to no room for interest rates to be reduced to prevent the economy dropping into recession. This is a major risk.

Company profitability is abnormally high

The other important issue is that earnings are at abnormally high profitability levels. Average global operating profit margins are 12% versus the long-term average of 8%. This reduces the ability of companies to grow earnings into the future at high rates in order to support the current high valuations (high P/E). This adds to the risk that it will be difficult to produce future high profit growth, which is needed to support current high valuations.

Secondly, If history repeats itself, global equities are set for poor returns for the next 10 years.

Global and local returns over the last three decades

Global and local returns over the last three decades

From 1990 to 2000, global and local equity returns were 22% p.a. and 15% p.a. in Rands respectively. The following ten years – 2000 to 2010 – global equity returns slowed to 2% p.a. and local returns were 16%. The last 10 years have seen global equity returns of 17% p.a. and local returns of 11% p.a.

This illustrates that sometimes periods of strong growth are followed by periods of slow growth, which means if history repeats itself, a period of slow growth is likely for offshore investments.

So, what should we do if we want to invest offshore?

Given the massive size of offshore markets, there are still good investment opportunities. However, one needs to find the right funds that will provide a better risk-adjusted return, such as emerging markets rather than developed markets. Value sectors rather than growth sectors.

Like all investment decisions, choices need to be in the context of your personal risk profile. If you can stomach a volatile investment, then a higher long-term portion can be allocated to offshore equities. And vice versa.

The right approach is to have a diversified investment portfolio with an appropriate offshore allocation. This will largely be driven by your long-term goals.

To achieve this, the best advice is to do a financial plan that will facilitate the right investment decisions. Speak to one of our Financial Advisors to get you started.

Please click here to watch our digital financial planning video.

 

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