Theuse of stock options as part of executives’ remuneration led to an unspoken pact between investors and corporate management that has exacerbated the current malaise in global equity markets, according to John O’Callaghan, portfolio manager for Putnam Investments.
Speaking recently as a guest of Sagitta Wealth Management, O’Callaghan said that accounting practices, particularly in the US, had become embroiled in a cycle of greed, not surprising in the context of such a long bull market.
Executives having their salaries tied to the company stock price, “caused some people to overstep the line”, O’Callaghan says.
Legislation to take effect in August this year requiring US chief executive officers to sign off financial reports and be liable to criminal charges if they are found to be fraudulent, will go some way to stemming the corruption flow, he says.
Consequently, while the US economy is showing signs of recovery, equity markets will take a while to follow suit until investor confidence returns.
“Consumer spending is probably the most important driver of the US economy and it has remained very robust. What is dragging the US equity markets down is non-US investors, which have had quite negative sentiment of late,” O’Callaghan says.
Consequently, Putnam is currently slightly under weight in the North American region but he says it still represented more than half of the group’s portfolio.
Elsewhere, “the property market in the UK is deemed as in a bubble phase and so interest rates are likely to put pressure on the market there,” he says.
Japan is still seen as something of a disaster zone, although ironically the short-term prospects for the Japanese economy is much better than the long-term. The reason for this being that it is anticipated that business and government in Japan will continue to put off reform, which in the short-term will continue to prop things up, but means that the long-term view is extremely gloomy.
“Domestic demand is very weak, interest rates are at zero and public debt is extremely high with highways, bridges and airports to nowhere,” he said.
Among the regions Putnam does like are Asia (ex-Japan), which O’Callaghan sees as “participating in an export-led boom as surprisingly orders for semi-conductors have become quite high, which Asia is very much tied to”.
“Commodity markets in general, particularly in Asia, during a global economic recovery tend to do better than the developed markets,” he said.
Continental Europe is also in favour as the markets are “delivering boring, steady growth” and are relatively stable as companies there are less affected by stock options, and so perceived as being that much less likely to unveil WorldCom-style accounting surprises. Reporting in Europe also only takes place every six months, which in these times of market angst, is seen as a good thing.
