What is your overview of the global markets?
In spite of the volatility over the last week, our outlook for the global equity markets is still positive. Global earnings growth for 2019 remains positive at 4% (remember coming off a higher base from last year). Although some GDP forecast has been revised downward since the start of the year, especially in Europe, Australia, and China, GDP forecasts are still positive for most markets around the world, with the possible exception of Argentina and Turkey. Global GDP forecasts for 2019 are 1.8% for developed markets and 3.4% for emerging markets.
Given your optimism, when do you think the Bull Market will end?
This global bull market has lasted a long time. As they say about horses, it has become long in the tooth. The current Global Bull Run has lasted 94 months if you start counting from September 2011. This was when the global markets had their last decline of 20% or more. The bull market run is longer for the US markets since the US market did not decline by 20% in 2011. So the current rally for the US is longer than 94 months. This 2nd longest bull market in history since 1970.
What we have found was that most bull markets end did not end due to length but due to shocks to the global economy, which cause recessions and subsequent double-digit earnings declines.
What About Valuations of the market? Aren’t they high?
Valuations are not cheap but not in bubble territory. The global P/E based on 12-month trailing earnings is around 18x, which is slightly below is its 20-year average of 19x. For the U.S. the P/E is around 21x, which is slightly higher than its 20-year average of 20x. There are other ways of measuring Global Valuations, including price divided by 10 years of earnings. This P/E based on 10 years of earnings is also around 20x, which is high but not in bubble territory. During the Tech Bubble, this P/E was 50x.
What are the Biggest Risks?
Obviously, an outright trade war is the biggest risk. Right now, we are dealing with the unpredictability of trade policy and the beginnings of a trade war. The unpredictable trade policy has thrown the world a curveball. Manufacturing is slumping around the globe, and growth is slowing in Europe and China. The unpredictability has begun to weigh on business investment. Supply chains might be disrupted. It is expected that tariffs will be a drag on corporate earnings.
Brexit is also a risk. This is also a trade policy. A hard Brexit will probably throw the U.K. into a recession and slow Europe even further. Who will know what will happen between Ireland and Northern Ireland? Will the conflict start again in Northern Ireland?
In other words, if there is a real trade war, all bets are off. There are no winners in an outright trade war. China can boycott US products, can make it more difficult for US businesses in China, can devaluate their currency more. Other markets can do competitive devaluations of their currencies.
I would expect that Trump and China will stop at an outright trade war. Trump wants to be re-elected in 2020 and will compromise with China on trade and declare it a victory.
Which markets do you favor for equities?
What I am about to say has to be prefaced that we are not going to have a major trade war and one should have a diversified portfolio which includes equities from a number of markets. With that caveat, some of the markets which we are favoring (overweight in a diversified portfolio) are contrarian because they have gotten cheaper with the trade and political worries. As an example, Singapore’s P/E of 13x is cheap on an absolute basis and relative to its own history and offers a high 3.9% dividend yield. Although Italy has one of the weakest economies in Europe, its sovereign yields spreads are coming down from where they were over the last several years. Spanish valuations are cheap (forecasted P/E of 12x), and in contrast to other markets, GDP forecasts are being upgraded.
How do you see Emerging Markets and which emerging markets do you favor?
We feel many emerging market risks which we saw historically are contained. Sovereign spreads over treasuries, which is a measure of risk for emerging markets, remain at historic lows. Most currencies are not overvalued or undervalued – the exceptions being Pakistan and Colombia which are substantially undervalued. Currently, there is only one Emerging Market (Pakistan) with a large current account deficit as a percent of GDP (that is it is importing a lot more than exporting), which was a symptom and cause of previous emerging market crises.
We are overweight, Brazil. Brazil is a controversial market. There is a lot of negative sentiment right now about Brazil. However, the real is undervalued, and sovereign risk spreads have been narrowing.
We are overweight Taiwan which is reasonably priced and is what we call a low beta market (low correlation with other markets around the world) and which can serve as a diversifier to the rest of the portfolio.
What Allocations would you recommend?
Would I change one’s strategic allocation now, in other words, reduce equities and increase cash, fixed income, other asset classes. No, I would stay put.