World shares have struggled to regain the ground lost since the sharp sell-off in October. At its current level, the MSCI World index of developed markets in U.S. dollars is still 7.8% below its recent peak on 27 September, and is 9.8% below its all-time high back on 26 January.
The overall global outcome has continued to depend disproportionately on the U.S. market; US stock markets having seen gains for the year wiped out this week after poor results from retailers and fears over slowing smartphone sales. Japanese shares have been the least bad, with a 2.2% fall in the Nikkei index, but European shares have been weak, with the FTSEurofirst 300 index down 6.9%. German shares have been among the weaker of the major European markets, with the DAX index down 12.3%.
The U.K. has also struggled, with the FTSE 100 index down if the Brexit negotiations reach a negotiated conclusion rather than the "hard" Brexit that has been worrying the U.K. equity market, the outlook may improve.
Emerging markets have been worse again after initially specific worries about Argentina and Turkey spread to the asset class as a whole. The MSCI Emerging Markets index in U.S. dollars is down 16.6% year to date, and the core BRIC component; Brazil, Russia, India, China, is down by a similarly large 15.6%.
International Equities — Outlook
The dependence of the overall asset class on U.S. performance has been understandable: profits have been booming in the U.S. but have been harder to come by elsewhere. According to U.S. data company FactSet, the S&P 500 companies will have increased their earnings per share by 20.6% in 2018.
While the overall number is somewhat inflated by a doubling of profits in the energy sector, profit growth has been widespread, and is at double-digit rates in eight of the 10 sectors FactSet breaks out, and is reasonable in the other two; consumer staples, up 8.8%, and real estate, up 8.%.
There is still no clear indication that the U.S. economy has run out of profit-generating steam. Profit growth in 2019, according to the stockbroker analyst forecasts that FactSet collates, is expected to be 9.2%.
The analysts believe that this will be enough to carry the S&P 500 up to 3,181 in a year's time, which would be a 16.7% rise from current levels. Interestingly, the fund managers surveyed in the latest BAML survey said they think the S&P 500 will peak at 3,056, not as bullish as the FactSet analysts but still on track to what would be a solid gain from current levels of some 12%.
Not everyone in the fund manager community is convinced; 30% of respondents believe the peak for the S&P 500 is already behind us, a significant rise on the 16% who had thought so in the October survey, but there are reasonable grounds to expect the U.S. economy and its equity market will hold up well. The fund managers continue to be overweight to the U.S. market.
What Will the Global Economy Do?
So far, the economy is living up to their expectations as the U.S. economy continues to do well. The October employment report showed for example that there were 250,000 extra jobs in the month, more than the 190,000 that forecasters had been expecting, and the unemployment rate remained at a low 3.7%. There are risks: the current fiscal stimulus will progressively run down – and will not be renewed with now-divided control of Congress between Democrats and Republicans; there are more questions being asked of the prospects for the big tech stocks, which up to now have been a disproportionate source of U.S. equity gains; and the recent sharp drop in world oil prices brings the expected profits of the U.S. "fracking" industry under a new spotlight. But all that said, there is a reasonable prospect of U.S. gains supporting the outlook for the asset class.
Elsewhere, the good news is that the global economy looks set for ongoing expansion, but the bad news is that the rate of growth looks like slowing down. It would be nice if the latest reading from the J.P. Morgan/IHS Markit Global Composite PMI, which measures the momentum of global business activity, was the harbinger of more good news to come: in September the Composite PMI had shown unusually slow world growth, but in October it perked up again.
J.P Morgan said: “The start of the final quarter saw a modest improvement in the rate of expansion of global economic output, as a stronger performing service sector offset the ongoing slowdown at manufacturers."
It is somewhat more likely, however, that 2019 will not be quite as good a year for global business activity as 2018. The BAML fund managers certainly feel that way: 44% of them think the world will be growing more slowly in 2019, though only 11% think the outlook will deteriorate all the way into recession.
Somewhat oddly, the fund managers have fancy expectations for non-U.S. equities in these conditions: they think non-U.S. equities will be the best-performing asset class in 2019, well ahead of the S&P 500 and commodities as their next best bets. Perhaps one answer is that they expect the last leg of the S&P 500 gains to occur over the next few months, with non-U.S. equities kicking in later.
Another possibility is that fund managers regard some of the non-U.S. markets to have been oversold in the recent decline, in September, for example, the fund managers had been a net 10% underweight to emerging markets, whereas in this latest November survey, they are now a net 13% overweight. The past few months have been trying for international equity investors, and there are still significant risks to be faced with the top three, for the BAML respondents: trade wars; monetary policy mis-steps; and a slowdown in China, much the same trio that they have worried about all year.
But there is still a reasonable chance the ongoing world business cycle will muddle through over the coming year, and provide some fundamental economic support for better equity performance.
