Geopolitical risk will undoubtedly be an important and ongoing focus for the market in the months ahead. This will, in our view, centre around two key areas: first, U.S.-China trade tensions, and second, Brexit visibility (and the ongoing uncertainty of its outcome). The former will feed into the longer-term outlook for Chinese and U.S. economic momentum, and by extension, drivers of global economic growth. Although Chinese authorities have continued to take action this year to avoid a hard landing for their economy, there is the ongoing risk of a weakening of momentum at this stage.
This will in turn lead to a secondary focus for the market on the macro front, namely the need to assess monetary policy actions across the regions. The U.S. Federal Reserve has been more vocal about the potential need for interest rate cuts, as has the European Central Bank, so a more accommodative monetary stance is likely to be a theme for the rest of the year and beyond.
On the economic growth front, leading indicators are weak across all regions, which highlights downside risk to GDP estimates and earnings forecasts. In our view, equity valuations are relatively more supportive in Asia and Europe than they are in the U.S., although the backdrop of weakening economic momentum means that monetary policy assessment has become an important aspect to consider when assessing both direction and style leadership in the market.
Impact of Tariffs
We believe that the current impasse over tariffs has minimal potential to affect the long-term outlook for equity markets. Our view on the long term has not changed – we continue to see a lack of inflationary pressures, and in fact, strong underlying deflationary currents brought by technological disruptions. In this environment, we continue to focus our fundamental research work on finding undervalued companies with attractive, sustainable returns, good growth profiles, and strong balance sheets, as well as those that offer good compounding characteristics over the long term.
Growth: Turning a Corner
The Momentum Continues
Cautious Optimism for Equities
Realistic About Risk
Looking Beyond the U.S.
Where Do We Go from Here?
U.S.-China: Fallout from Trade Tensions?
Royce & Associates
Resilient Growth, Despite Uncertainty
Midyear Outlook: Asia, Emerging Markets and Europe
Europe Overview - Steve Frost, Portfolio Manager
Key Themes: European and global macro data continues to be soft: while service data is holding up, manufacturing numbers remain in recession (but stable). German growth is suffering from weakness in the automotive industry and the effects of confusion regarding trade tariffs. Worryingly, input prices are rising. Either these must be passed on, or it will result in reduced profit margins. There is certainly a risk in our opinion that global economic growth after the summer is weaker than forecast.
The great globalisation trend of the last two decades is undoubtedly likely to slow. Corporate capital allocation will become more local, rather than overly focusing on developing economies. Initially, this may reduce global investment and hence growth, but in the medium term this may potentially benefit Europe and spread growth prospects more evenly throughout the world. However, the current structural problems within Europe are likely to continue to be a drag on growth prospects and, in the shorter term, there is a risk of recession.
Areas of Opportunity: Valuations are above trend for the large majority of European equities. Only the most cyclical stocks, such as steel and chemical companies, are now closer to trough price-to-sales valuations. For now, we prefer to observe how bad the earnings of cyclicals will become, rather than buy before the trough given the weakening growth outlook. We are though, expecting to see some good opportunities in quality cyclicals which are de-rating during this environment. On the shorting side, we see a lot of companies are at peak valuations, which means we are looking to take advantage in anticipation of a de-rating back towards long-term average valuations.
Emerging Markets Overview - Alastair Reynolds, Portfolio Manager
Key Themes: In emerging markets (EM), what happens next politically in several of the biggest markets will be an important theme. In Brazil and Mexico, we have new and unproven administrations in place that have ambitious reform plans. In India, we have just seen the re-election of a coalition which aims to pursue its own clear reform agenda. These political themes can periodically distort valuations of different countries materially and this is something we seek to counter in our portfolio construction by not taking excessive country risk.
Meanwhile, although we do not seek to forecast macro factors, we acknowledge moves in interest rates can have a powerful impact on the valuation of equities and we use long-term interest rates in our bottom up stock-picking, adjusting these periodically to remove volatility from our analysis. Currently, what we are seeing is a renewed bout of downward pressure on long-term (and in some cases short-term) interest rates globally, which may well prove to be a notable theme for asset prices.
With regard to the continuing standoff over tariffs, this will typically cause those companies with more direct exposure to international trade to perform less well than many companies which are primarily driven by domestic demand. The true exposure of any one company to tariffs is though, a far more nuanced issue which incorporates complex value chains and brings a range of market-share opportunities and threats. We take a longer-term view on companies, which helps us to look through bouts of excessive volatility in individual share prices.
On a 10-year view in basic price-to-book value terms versus history, the EM equity index is at a wide valuation discount compared with the world equity index. This is despite the fact that the EM equity index offers very similar profitability and better aggregate profit growth potential.
Areas of Opportunity: We believe India offers us excellent relative growth characteristics and, in many cases, very technologically advanced companies by both emerging market and global standards. All the Indian stocks in our portfolio are domestically focused companies, which gives us the additional comfort of holding stocks that are, at least partly, sheltered from trade fears.
We continue to find attractive companies in many parts of the broader IT sector. We are overweight technology, but this is built on a combination of subsector exposures with diverse underlying drivers – from internet platform companies and a variety of component companies to IT services businesses. What these companies do have in common is strong underlying end-market demand, with a range of cyclical influences.
Asia Overview - Andrew Graham, Head of Asia
Key Themes: Global central banks have certainly become more dovish in recent months and this is a tone that we largely expect to continue for the rest of the year. What this means is that, rightly or wrongly, central banks are chiefly indicating (or implementing) moves towards accommodative policy positions – which are generally supportive of asset prices.
Of course, global trade policy is also likely to remain a global theme for the rest of the year. So far, the trade war between the US and China has undoubtedly elevated uncertainty and is having a negative, if manageable, impact on growth. While a trade war between the world’s two largest economies is a clear negative for the Asia region, we believe the effects will be somewhat mitigated by Asia’s growth drivers which are secular in nature. That said, a sensible resolution to the trade dispute would be well received by markets.
Areas of Opportunity: Given the long-term secular drivers of the expanding Asian middle class, increasing investment in technology and innovation, urbanisation and the investment in infrastructure, we believe the consumer and technology sectors offer some of the most attractive growth opportunities. However, there are stocks in other sectors that also touch on these drivers – such as the insurance sector – which has the opportunity to meet the sizeable protection gap in the region with attractive, innovative solutions.
Looking regionally, we are positive about China, because valuations are reflecting much of the uncertainty about the trade situation and longer-term secular growth opportunities are now being mispriced. Indonesia should benefit from more accommodative monetary policy globally; consumer sectors are cycling through the difficult growth environment and the outlook is improving. Meanwhile, in Hong Kong, while the local economy is more exposed than most to problems in the overall trade environment, we believe the stock market includes companies with really attractive long-term secular growth characteristics.
Unconstrained Overview - Zehrid Osmani, Head of Global Long-Term Unconstrained
Key Themes: Geopolitical risk will undoubtedly be an important and ongoing focus for the market in the months ahead. This will, in our view, centre around two key areas: U.S.-China trade tensions and Brexit visibility (and the ongoing uncertainty of its outcome). The former will feed into the longer-term outlook for Chinese and U.S. economic momentum, and by extension, drivers of global economic growth. Although Chinese authorities have continued to take action this year to support their economy, there is the ongoing risk of a weakening of momentum at this stage.
This will, in turn, lead to a secondary focus for the market on the macro front, namely the need to assess monetary policy actions across the regions. The U.S. Federal Reserve has been more vocal about the potential need for interest rate cuts, as has the European Central Bank, so a more accommodative monetary stance is likely to be a theme for the rest of the year and beyond.
Areas of Opportunity: On the economic momentum front, leading indicators are weak across all regions, highlighting downside risk to GDP estimates, and to earnings forecasts. In our view, equity valuations are relatively more supportive in Asia and Europe than they are in the US, although the backdrop of weakening economic momentum means that monetary policy assessment has become an important aspect to consider when assessing both direction and style leadership in the market.
Importantly though, we do not look at the market in terms of sectors/countries’ relative valuations – we focus our research work on stocks that offer an attractive growth and returns profile, operating in supportive industry dynamics, with higher barriers to entry and strong pricing power, as well as low disruption risk. We note, however, that emerging market equities remain attractive for long-term investors.
Elsewhere, the inclusion of Chinese A-shares in more global indices should provide more opportunities for active investors, although one needs to remain selective. It will also increase liquidity, but will also lead to some technical flows as index weights are amended.
Finally, we believe that the current impasse over tariffs has minimal potential to affect the long-term outlook for equity markets. Our view on the long term has not changed – we continue to see a lack of inflationary pressures, and in fact, strong underlying deflationary currents brought by technological disruptions. In this environment, we continue to focus our fundamental research work on finding undervalued companies with attractive, sustainable returns and good growth profiles, as well as strong balance sheets, and those that offer good compounding characteristics over the long term.
The MSCI World Index is an unmanaged index of common stocks of companies representative of the market structure of 22 developed market countries in North America, Europe, and the Asia/Pacific Region. The index is calculated without dividends, with net or with gross dividends reinvested, in both U.S. dollars and local currencies. Please note an investor cannot invest directly in an index.
The MSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The price-to-book (P/B) ratio is a stock's price divided by the stock’s per share book value.
The price-to-sales (P/S) ratio is a stock's price divided by its sales per share.
A shares, also known as domestic shares, are shares that denominated in Renminbi and traded in the Shanghai and Shenzhen stock exchanges, as well as the National Equities Exchange and Quotations.
ESG is an abbreviation for Environmental, Social and Governance
Gross Domestic Product (GDP) is an economic statistic that measures the market value of all final goods and services produced within a country in a given period of time.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
"Brexit" is a shorthand term referring to the UK vote to exit the European Union.
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