Global Equity Views 2Q 2019Contributor Paul Quinsee
Themes and implications from the Global Equities Investors Quarterly
- While our portfolio managers are more cautious after the first quarter’s gains in equity markets, we still see good reasons to stay invested.
- Emerging market equities look attractive even after a strong rebound from October’s lows. UK equities, which are trading at a significant discount to the broader market, also present some interesting opportunities despite the obvious uncertainties of Brexit.
- With the value style near historical lows relative to growth and amid renewed concerns about the economic outlook, our investors are finding opportunities in higher-quality value-oriented and cyclical stocks.
- Trade and tariffs remain the biggest risks to our outlook; our investors are also watching for signs of a recession.
After a rip-roaring recovery from the miserable end to last year, it is easy to think of reasons to take a more cautious view of the prospects for world equity markets. In particular, analysts have steadily lowered profit forecasts around the world amid sluggish growth in the major developed economies and concern over the outlook in China. The message from bond markets is to expect more of the same, with the U.S. yield curve temporarily inverting recently and the troubling sight of negative yields on government debt once again spreading across Northern Europe and Japan. Given that the U.S. economic expansion is already the second longest in history, investors are understandably anxious about the outlook for growth and profits over the next couple of years.
Our portfolio managers are also more cautious after recent gains, but we see some important reasons to stay invested. Equity market valuations still look very reasonable despite the jump in prices during the last three months; moreover, international and emerging market stocks are at an unusually wide discount to U.S. equities. Compared with the returns on offer from bond markets, stocks again look cheap around the world. And within markets, the discount for taking risk is still unusually large, with valuation spreads between low and high priced stocks wider than average. All of this suggests that investors are well aware of the near-term challenges, and sentiment toward equities remains far from exuberant. Meanwhile, amid a subdued economic outlook, we see more signs that management teams are embracing “self-help” strategies in Europe and Japan, while U.S. corporations are still buying back stock to return capital to shareholders at historically generous levels.
Our earnings forecasts have continued to drift lower, as they have since mid-2018, and we see more modest growth this year. Lower commodity prices and softer growth have weighed in particular on the industrial sectors, while parts of technology have also cooled down. Looking further out (which we think is the more important perspective), we still believe that profits in many more cyclical sectors are above sustainable levels, although the correction is already underway in the semiconductor space. In the emerging world, profit expectations have also fallen, but there are some tentative signs of improvement recently—a less than robust outlook, to be sure, but only modestly different from how we saw things a year ago. Of course, a U.S. recession would change that, but aside from the signals from the yield curve, we don’t see the typical warning signs yet.
A more tempered outlook for economic growth is helping encourage companies to focus on shareholders, both by returning capital and restructuring to improve profitability. In Europe, it appears that net equity issuance is now negative for the first time in a decade as buybacks gradually increase, while similar practices are slowly gaining more traction in Japan (EXHIBIT 1). However, attitudes still vary tremendously from company to company, which provides interesting opportunities for stock selection. U.S. companies continue to enthusiastically return capital at record levels, with a growing list of activist investors quick to chase any perceived laggards.
As buybacks gradually increase, net equity issuance is now negative for the first time in a decade
EXHIBIT 1: Europe stock buybacks and equity issuance, 12-month rolling,USD billions
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