It has been a volatile year for global equities. It started with strong rise in January, a substantial decline in late January and early February, followed by a recovery that never took proper hold, by early April, prices were back to their early February lows. More recently, there has been a slow rise in prices, but the recent gains have barely been enough to generate a year-to-date capital gain.
The MSCI World index of developed markets is up only 2.3% in the overseas markets’ currencies and by only 1.5% in U.S. dollars. Prices remain below their late January peak, with the MSCI World still 3% adrift of its 26 January level.
Among the major markets, the U.S. has been doing best as its growth prospects have improved relative to other regions. The S&P 500 is up 4% in capital value year to date, while the tech-heavy Nasdaq index is up a strong 12.2% on the back of good performance by an in-demand sector. Other major markets have shown little net movement, with Japan's Nikkei up 0.4%, and the FTSEurofirst 300 Index of European shares down slightly.
In the U.K., shares are also down a little. The emerging markets have been weak in the wake of sharp setbacks in Argentina and Turkey which have sensitised investors to the risks of the emerging markets more generally.
The MSCI Emerging Markets is down 3.9% in U.S. dollars, although the key BRIC markets – Brazil, Russia, India, China – did better than most, largely attributable to China. The two countries that sparked investor alarm have continued to struggle, with MSCI Argentina index down 35.4% and the MSCI Turkey index down 34.9%.
International Equities — Outlook
The world economy is still enjoying a largely synchronised business expansion. Virtually every sector is growing, according to the IHS Markit Purchasing Managers Index (PMI) measure which is based on aggregated single country PMIs. In May, it showed that all seven broad sectors it monitors were doing well, led by the industrials and technology, and nearly all of the 22 subsectors were also expanding, with the sole exception of mining. It is a similar picture when the world economy is looked at regionally, although there have been some recent shifts in relative performance.
The May JP Morgan Global Composite performance index, also based on the same country PMIs, “signalled a further uptick in the rate of global economic growth ... Robust inflows of new work, rising employment and positive business sentiment should all support further output growth during the coming months.”
The latest uptick, however, owed a lot to the U.S., where faster growth has made up for steady growth in China and slower growth in the eurozone, Japan, India, and Russia. In the U.S., the latest data showed the unemployment rate dropped to a new low of 3.8% in May, and the economy generated rather more new jobs than forecasters had expected. Share analysts believe the strength of the U.S. economy will translate into substantial rises in U.S. corporate profits.
On the latest analyst forecasts collated by data company FactSet, profits for the S&P 500 companies are expected to rise by very nearly 20% this year, and by a further 10% next year. The new relative pecking order has not gone unnoticed by fund managers. As the June BAML survey showed, they have moved to a slight overweight allocation to U.S. equities for the first time since March 2017.
The increased allocation has been funded by less overweight allocations to the eurozone, where economic data have been on the weaker side of expectations, and to emerging markets, where as noted earlier, risks have risen in a number of developing economies. The economic fundamentals are still supportive of equity price gains, especially in the U.S.
The analysts polled by FactSet think the S&P 500 will reach 3,090 in a year’s time, a gain of some 11%, while the fund managers surveyed by BAML see the index peaking at around 3,040, which would be a gain of around 9%. But there is no denying that the global expansion is now getting on in years, and the odds of an interruption to the expansion at some point in the next year or two are rising.
In the BAML survey, for example, respondents were evenly split over whether or not the world economy will be stronger in a year’s time. As well, the risks are rising and mutating. At the time of writing, the trade dispute between the U.S. and China had worsened, with President Trump threatening to impose tariffs on an additional $200 billion worth of Chinese goods, on top of the $50 billion previously targeted, and to which China had responded with a similar-size tariff package of its own.
Confrontational protectionist policies raise a real risk of disruption to the global economy, and the BAML managers now rate trade wars as the single most worrying risk, ahead of a monetary policy mistake by either the Fed or the ECB, and the risk of a eurozone financial crisis.
If the economics prevail, world equities should be able to make further gains. But protectionism, in particular, and the potential for other policy mistakes and geopolitical shocks, mean that gains, if they come to hand, will be achieved in choppy markets, and the volatility seen year to date is likely to remain a feature of the markets.
