The good news is despite the trio of worries; rising interest rates, trade wars and the suggestion that the world economy may not be growing as rapidly as expected, world shares are slightly up for the year.
The bad news is that they have yet to regain the ground lost from the two big sell-offs in January and March which occurred when investors first started to take these concerns more seriously. Year to date, the MSCI World index of developed markets is up 1.3% in the markets’ own currencies, and up 0.8% in U.S. dollars.
Few of the major markets have stood out from the pack, with most registering small increases in local currency terms. In the US, the S&P 500 is up 1.5%; in Japan, the Nikkei has gained 1.2%; and in Europe, the FTSE Eurofirst 300 index is up 1.2%, with the French market a rare example of a larger gain; CAC 40 index up 5.7%.
What About Emerging Markets?
Until very recently, the emerging markets had been handily outperforming their developed economy counterparts, but they have faltered in recent weeks, with the MSCI Emerging Markets up only 0.7% in the emerging markets’ currencies and making a 1.8% loss in U.S. dollars. Investors who stayed in the key BRIC markets of Brazil, Russia, India, China, fared relatively well, with the MSCI BRIC index up 0.9% in U.S. dollars, but anyone off the main beaten path ran into trouble.
Two countries in particular suffered big losses: the MSCI Turkey index dropped 25.9% in U.S. dollar terms, and the MSCI Argentina index, strictly speaking classed as a “frontier” rather than “emerging” market, fell by 24.8%. It was a reminder that, while growth prospects are higher, and valuations less expensive, in the emerging markets, they pose their own significant risks.
Other emerging markets to weaken in U.S dollars included Indonesia, down 18.75%, the Philippines, down 15.1%, Poland, down 13.2%, and South Africa, down 10.5%.
What is the Outlook for Equities?
The global economic outlook remains solid. As the April JP Morgan Global Composite performance index found: “The start of the second quarter saw a modest acceleration in the rate of expansion of global private sector economic activity. Although growth failed to recover and match the highs seen around the turn of the year, it remained solid and was in line with its long-run trend.”
It helps that the implausible contraction in the global technology sector that had mysteriously shown up in the March data reversed with a bang in April, with the sector having its best performance since September 2014. At the edges there has been the occasional hint growth may not be quite as strong as investors have been expecting.
Eurozone data, in particular, has been on the weaker side of expectations. Japan’s GDP unexpectedly dropped by 0.2% in the March quarter. And the international economists polled in May by the Economist magazine generally tweaked back their forecasts for 2019, other than slightly more upbeat views of Canada and South Africa.
Overall, though, the economic outlook is still a good fundamental base for equity performance. But there are growing risks. The global economic cycle is getting long in the tooth although as both forecasters and fund managers believe, it does not look as if it is going to fall over imminently. In the May BAML fund manager survey mentioned earlier, three-quarters believe equities have not peaked yet. But we are likely to be somewhere down the late stage of a long cycle, where risks of derailment are accumulating.
Global Growth to Slump?
In the BAML survey, only 1% favour the idea that the world economy can continue strengthening over the next year, though managers are roughly evenly split over whether the eventual slowdown will happen in 2019 or 2020.
Valuations are also an issue, particularly in the U.S and particularly, when rising U.S. interest rates are upsetting the previous basis of relative equity valuations. World equity prices have risen by 12.75% in U.S. dollars over the past year, even after the sell-offs in January and March this year.
That reflected a large price response to an acceleration in the world economy which had been given a further nudge along by big tax cuts in the US. But that was then, and this is now, and further gains of that order do not look likely when the odds now suggest an eventual slowdown rather than further unexpectedly good news. The BAML respondents also identified the risks they are most concerned about.
In order, they were potential monetary policy mistakes by either the Fed in the US or the European Central Bank in the eurozone, the fall-out from trade wars, and geopolitical risks that might send the oil price as high as $100 a barrel. So far, none of those risks has materialised. If anything, the rise thus far of the oil price has helped overall share prices rather than challenged them.
Energy Companies Face Headwinds
There have been strong gains this year for energy companies; both for conventional oil and gas and for alternative energy. All these torpedoes could yet go on missing their targets, and at the time of writing, the negotiations between the U.S. and China over potential trade concessions had, apparently, staved off at least the immediate threat of trade sanctions.
But realistically world equity markets cannot expect to dodge all the bullets, especially as more of them are being fired by a U.S. administration that has been more comfortable with confrontation, with Iran and North Korea, for example, as well as with China, than previous administrations.
If the global economic cycle were the sole determinant, the equity outlook would be reasonable, though unlikely to match the gains when optimism on growth was at its height. But risks, accidents and politics look as if they could have a spoiling role.
