Global Market Commentary

Money Keeps Flowing Into European and Emerging-Market Stocks — Here’s Why

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Money Keeps Flowing Into European and Emerging-Market Stocks — Here’s Why

We began to get bullish on European and emerging-market stocks a few months ago.  Now major financial media are joining us, citing the same data we’ve observed: a broad uptick in global growth and economic vitality is suggesting that markets which have lagged the U.S. for years may begin to close the gap.  Analysts continue to debate whether or not there is a disconnect between “soft data” (sentiment indicators) and the “hard data” (economic indicators), but from our perspective, earnings are the proof of the pudding, and both earnings and earnings revisions are good.

Leaving aside the U.S. for a moment, let’s concentrate on Europe and emerging markets as promising “reversion to the mean” stories.  EM earnings estimates have now climbed to the highest growth rate of the past six years.  2013 and 2016 were the sole years of growth for EM; 2012, 2014, and 2015 all ended nearly flat or slightly down.  2016 was 8.6% up; so far, estimates show this year up 19.6%.  

A similar story is unfolding in Europe, but showing an even more dramatic acceleration.  2014 eked out slight growth; every other year of the past five was down.  This year, estimates are for a 14.5% increase.

This is the kind of reversion we are happy to see.

The message is clear: EM and Europe are both set for strong earnings growth recovery, which should help their stocks re-rate to higher price-to-earnings multiples — closing some of the gap that exists between their current multiple and the historical norm of its relation to U.S. stock prices.

As we anticipated, the victory of Emmanuel Macron in France’s presidential election has resulted in large inflows of investment funds into Europe — although analysts note that large investors are on the whole still underexposed to European markets, so the process may have further to go.  Emerging-market debt is also continuing to attract inflows.  We are watching EM debt in countries with modest inflation, where central banks will be able to lower interest rates and currencies will be stable or improving against the U.S. dollar, and have invested in EM debt for some clients.

Earnings Are Growing — How Are Businesses and Consumers Feeling?

On the “soft” front, surveys of businesses and consumers, the data from Europe and EM continue to come in broadly strong.  Here are some data points from the most recent PMI releases from IHS Markit.  (PMI, or “purchasing managers index,” measures the sentiment of businesspeople about current and near-term business conditions in their countries.)

Among ASEAN nations (Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Cambodia, Laos, Myanmar, and Vietnam), rising output and new orders have boosted PMI to a 33-month high, with exports returning to growth after six months of declines and rising at the quickest pace since July, 2014.  Particular strength was noted in the Philippines and Vietnam.

Taiwan continued to show strong growth; the IHS Markit analyst noted, “The [manufacturing] sector is still enjoying its strongest… growth since 2011.  Manufacturers continue to benefit from strong demand both at home and abroad which has underpinned the upturn.”

Indian manufacturing is also accelerating.  The PMI news release noted: “Buoyant domestic demand coupled with sustained growth of new orders from abroad boosted the upturn in total new business… Having recovered at the beginning of the year from December’s demonetization-related contraction, growth of order books has [continued to gather] pace… Consumers were the key drivers of growth… The outlook appears encouraging too, with output expected to remain on an upward trajectory amid reports of planned capacity expansions, new product launches… and an improving economic scenario…”

In Brazil, the composite PMI (incorporating both manufacturing and services) registered above 50 — that is, in growth territory rather than contraction territory — for the first time in more than two years.  The analyst noted: “It’s encouraging to see Brazil’s economy on the rise after a prolonged downturn… positive news of expanding output was balanced across the manufacturing and service sectors.”  (Some Brazilian sentiment remains suppressed because there is still doubt about the pace of recovery, and ongoing political troubles continue with the fallout of the country’s big corruption scandal and the trial of its popular former president, Lula da Silva.  But many data suggest that a turn from the trough of the country’s recession has occurred.  Job losses are continuing, but at the slowest pace in the current 26-month period of declines.)  

Moving to Europe, manufacturing PMI expanded at the fastest rate in six years, driven by output, new orders, and employment.  Italy, France, and Austria all registered more-than-six-year highs.  The HIS Markit economist noted, “Eurozone manufacturers reported buoyant business conditions… Production, order books, and exports… [fueled] one of the largest increases in factory jobs in the 20-year history of the survey.  The latest survey readings indicate that manufacturing is growing at an annual rate of approximately 4–5%, which should make a significant contribution to overall economic growth… Optimism about the year ahead… appears unaffected by political worries…  Strong — and often accelerating — rates of growth were seen in all countries [except Greece].”

And it wasn’t just manufacturing — services showed similar strength, with composite PMI also rising to six-year highs.

This could be another reason suggesting the passing of “peak populism” represented by Macron’s defeat of Marine Le Pen in France — a strengthening economy will sap the strength of the political movements that have mobilized the wrath of the industrial working class.

Trouble in the U.S.?  There Are Other Places To Go

We noted to several clients early in the year that if the “Trump agenda” should be derailed by partisan conflict, or by internecine fighting within the Republican party, we were already watching Europe and emerging markets for opportunities to participate in the emerging global growth turn while reducing exposure to U.S. volatility.  We continue to see opportunities in Europe and emerging markets, based on accelerating economic growth; strong business sentiment; earnings acceleration; and a five-to-six year period of underperformance that offers the opportunity of a reversion to the mean.

Investment implications:  There are many country-specific and regional ETFs available for investors to gain exposure to Europe and emerging markets.  Within EM, we favor India, Taiwan, and possibly Singapore.  Within Europe, we favor ETFs which offer broad exposure to the economies of the EU.  Several ETFs are available which include currency hedges to protect against a decline of the euro versus the dollar.

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