Since the beginning of the year, global equity markets have managed to turn around the dismal performance of the final quarter of 2018. Year-to-date, the MSCI World is up almost 16% in US dollar terms and 17% in euro terms1. Notably, all major regional equity markets have kept up this pace, with the US just marginally ahead. The obvious laggard has been Japan, where an unfavorable USD/JPY exchange rate also contributed to the underperformance.
So, what’s next? Is this it? In my most recent conversations with clients, one recurring question has been: should we take profit from emerging markets after the rally? The question that I don’t get asked is: should we take profit from US equities and move it elsewhere? And while there seems to be an increased interest in specific markets such as China, the temptation to assume that the US equity market will continue to outperform as it has in recent years – while eventually the other major markets will fizzle out – is great.
We dare to utter the four most dangerous words ever spoken: “This time it’s different”. Let me rephrase that: “This time, it could be different, as long as a number of elements fall into place.”
What we believe will be different, is that there will be more opportunities for outperformance outside of the US. This does not mean that we expect the US equity market to collapse (if it did, it would take all other markets down with it), but simply that we believe that now that the sugar rush of President Trump’s tax cuts is over, the earnings growth differential between the US and other markets no longer warrants the wide disparity in valuations.
2019 IBES consensus earnings growth figures for the MSCI US, Europe and Emerging Markets are 4.1%, 5.5% and 6.8% and price/earnings ratios for 2019 are 17.2x, 13.6x and 12.1x, respectively. Of course, this is provided that earnings expectations outside of the US do not fall from the current levels and that the differential is maintained. This means that earnings revisions, which took a turn for the worse in all major markets during the last quarter of 2018, need to improve from the current levels.
The rally that we saw in 1Q was nothing more than investors realizing that the fourth quarter panic had caused stock prices to overshoot (on the downside) what was warranted based on fundamentals. The global economy was weakening, but not collapsing. And the dark clouds that were making the outlook appear even more ominous, namely a hawkish Fed and an escalation of the US-China trade conflict, did eventually dissipate.
Now, 16% later, markets have caught up with fundamentals. What we need now, is for an improvement in fundamentals to follow and eventually feed through to earnings.
Wide disparity in valuations no longer warranted
The first piece of the puzzle is a US-China trade deal. This is necessary for two reasons. First, because the start of negotiations has been an important pillar of the improved investor sentiment, and any negative news could reignite a bear market reaction. Second, because it would be a first step towards the reinvigoration of the weakened global economic activity. A good part of the global macro slowdown that we have witnessed in recent months has been due to the direct and indirect consequences of the trade dispute (as companies have either been directly impacted or have become more cautious with their spending plans).
Moreover, the trade deal does not need to be perfect, and it most likely won’t be. It just has to be good enough to scrap the tariffs that were imposed over the course of 2018. Any deal is likely to leave a lot of questions unanswered in the short term, whether they relate to the actual execution, the future of technology transfers, or any follow-through on a US-Europe trade deal. That said, none of those questions will have answers that could possibly be as bad for the global economy as the prospect of 25% tariffs on all goods traded between US and China.
Second, we need the world’s major central banks to continue to remain supportive, in other words, dovish. This is particularly important given the weak global macro backdrop. Take emerging markets, where equities have historically benefited from a strong growth outlook, regardless of the Fed’s stance (as was the case in the Fed tightening cycle of 2004-2006), but in a weak growth environment such as the current one, Fed support is a crucial element.
Third, we need the Chinese government to continue to gradually stimulate the domestic economy, managing the delicate balancing act between stimulus injection and debt management. We all understand that China’s economic growth will continue to weaken structurally, but as long as the government can manage the soft landing, investors will still be able to find compelling opportunities in the structural changes that are taking place in the country’s economy.
Of course, if the uncertainties surrounding the future of Europe, namely Brexit, the trade dispute between the EU and the US, and Italy’s woes were finally vanquished, that would be the icing on the cake. That said, we don’t want to be greedy and we feel that the markets should be able to cope with a bit more uncertainty on this end, as long as the other bigger boxes (China-US trade, central bank dovishness and China’s stimulus) are ticked.
We see all the required catalysts lining up for emerging markets, and some green shoots appearing. PMIs have started to improve in a few countries, namely China, Brazil and Indonesia, and earnings revisions seem to have reached a trough. Of course, we need to be mindful that emerging markets are not a homogeneous asset class, and some countries will fare better than others. China and Brazil are two that stand out in the current environment.
We believe Japan is next on the buy list, as some macro data is also taking a turn for the better, but earnings revisions remain weak. While we do find good investment opportunities in Europe and earnings revisions are also showing signs of having bottomed out, we see the risk of bouts of volatility ahead as markets look for clarity on Brexit, the US-EU trade talks and the trajectory of the Italian economy.
Based on the above, our investment team maintains its neutral outlook on developed markets, while its outlook on emerging markets has turned positive. In our five-factor framework, the emerging markets team has upgraded the sentiment indicator. This is owing to the change in the monetary situation in the US and the more constructive US-China relations, which, in turn, has led to a significant recovery of fund flows.
The global equities rally in the first quarter of 2019 was about realizing that the global economy was not heading off a cliff. For investor sentiment to remain upbeat, markets now have to show signs of improving fundamentals. If the pace of improvement is not limited to the US and other markets manage to maintain at least the same momentum, valuations in emerging markets, Japan and Europe will offer more compelling opportunities. Then, this time it really will be different.
1 Total Return
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.