Time for international equities to shine?
For most of the past decade the global stock market has persistently underperformed the U.S. Portfolio manager Thomas Banks explains why the tide may finally turn this year.
Q: What’s your overall outlook for international stocks?
We became more constructive in our outlook in the middle of last year and we remain sanguine entering 2020. The start of 2020 looks like the mirror image of early 2019—12 months ago investors were grappling with a hawkish Fed and a sharp deceleration in global manufacturing given the U.S.-China trade dispute and possibility of a no-deal or “hard” Brexit threatening to pull the major global economies into recession.
Instead, the Fed reversed course and cut its target rate three times, the U.S. and China agreed to Phase One of their trade deal, which crucially included an agreement to halve some existing tariffs and halt additional ones, and the U.K. and European Union (EU) reached a withdrawal agreement. With these key uncertainties partially resolved and rates remaining low, the slowdown in global manufacturing as measured by the Markit PMIs looks to have bottomed in July, easing recession fears.
These positive developments were recognized by the market which, after the late 2018 sell-off, produced a year of strong equity returns across all asset classes, just not as strong as in the U.S. With global indexes at or near all-time highs, we continue to believe there’s more upside for international equities for three key reasons. No. 1, Europe and Japan should be key beneficiaries from the ongoing rebound in manufacturing. No. 2, valuations are far from stretched—the MSCI Europe Index just got back to its 2015 levels and trades at a forward P/E multiple of 15, in line with its long-term average. There could be room for multiple expansion and earnings upgrades if growth accelerates. And No. 3, the U.S. dollar remains near a two-decade high against the major world currencies, depressing returns for U.S.-based investors who invest abroad. If this unwinds, whether driven by narrowing growth and/or interest rate differentials or through policy intervention, U.S.-based investors who are invested abroad will reap the benefits.
Q: What could deter progress?
We see four potential sources of uncertainty:
- Fear of the unknown Recent headlines have been dominated by the breakout of the coronavirus. Viruses historically have been disruptive to travel and leisure activities for a couple months before they are fully contained. This new development is impossible to predict and could weigh on growth, especially in Asia, for at least the first quarter. This unexpected risk could delay our scenario of a rebound in global growth.
- Political risks 2020 is an election year in the U.S. and until the polls close in November, it will produce a source of uncertainty. In addition, ongoing social unrest in countries such as France, Hong Kong, Chile, Spain, Brazil, etc., create ongoing political uncertainties.
- Geopolitical risks Relations between the U.S. and Iran remain tense while escalations in other parts of the world are always a possibility.
- Trade uncertainty U.S.-China relations remain contentious even after the Phase One deal and additional tariffs could be implemented if those agreements aren’t met. The U.K. officially exits the EU at the end of January and has until the end of the year to secure a new trade agreement with the EU. France and the U.S. announced progress on their digital tax dispute and agreed to hold off on retaliatory tariffs for at least one year, removing one source of trade uncertainty.
Q: What about Japan?
Consensus expectations are low for Japan as current estimates assume GDP growth will halve from an estimated 1% in 2019 to 0.5% in 2020. Short-term growth appears to be under pressure from October’s consumption tax increase, and a negative GDP print in 2019’s fourth quarter is likely.
Beyond that, however, there are several reasons to be optimistic on Japan longer term. First, its two largest export partners are China and the U.S., representing close to 20% each. As trade begins to normalize between the two countries and manufacturing bottoms, Japan should be a key beneficiary as its exports have been in decline for 13 consecutive months. We also think the October consumption tax increase could be less of a drag versus the last increase in 2014—household spending already rebounded 2.6% on a month-over-month basis in November. Also, in early December, the government announced a $120 billion stimulus package centered on stimulating consumption and infrastructure investments, which should soften the impact from the tax increase. Finally, Japan is hosting the 2020 Olympics this summer and current estimates are for the games to provide a $300 billion boost to the economy.
With numerous growth tailwinds and a wide gap between the consensus expectation of 0.5% GDP growth, the Bank of Japan’s forecast of 0.9% and the government’s 1.4% projection, we believe the consensus forecast could prove to be pessimistic.
Q: What’s your take on emerging markets?
If growth has bottomed and this year becomes the year of reflation, emerging markets (EM) should be a key beneficiary. Higher commodities, a weaker U.S. dollar and higher growth are all supportive for the asset class. Our investing approach is based on individual company fundamentals and, with that being said, Brazil is our most positive EM view. Not only are we seeing several well-run businesses there with robust growth outlooks, but the macro backdrop continues to improve. Brazil’s government has passed sweeping reforms, including an overhaul of the country’s pension system, while unemployment continues to trend downward and the central bank cut its target funds rate to a record low 4.5%. This has led economists to forecast an acceleration in Brazil’s GDP growth from 1.1% in 2019 to 2.2% in 2020.
Outside of Brazil, we also have a positive outlook on Poland, currently the fastest-growing economy in the EU with GDP growth of around 4% in 2019. We also are more optimistic on Mexico and continue to see opportunity in China and Thailand.