Midyear Outlook: Asia, EM and Europe

Midyear Outlook: Asia, EM and Europe

A region-by-region breakdown of the most relevant issues for global equity investors to follow in the months ahead.

Photo of Shanghai City
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.

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.

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.

 

DEFINITIONS

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.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.