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Developed market stocks edging ahead of emerging

Peter Gee  |  29 May 2018Text size  Decrease  Increase  |  
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One of the few emerging markets that has posted positive performance recently is Brazil. Rio de Janeiro pictured

Despite a global scenario of rising interest rates, trade wars and suggestions the world economy overall is not growing as rapidly as expected, world shares are slightly up for the year.

The bad news is that they have yet to regain the ground lost from the two big sell-offs in January and March which occurred when investors first started to take these concerns more seriously. Year to date, the MSCI World index of developed markets is up 1.3 per cent in the markets’ own currencies, and up 0.8 per cent in US dollars.

Few of the major markets have stood out from the pack, with most registering small increases in local currency terms. In the US, the S&P 500 is up 1.5 per cent; in Japan, the Nikkei has gained 1.2 per cent; and in Europe, the FTSE Eurofirst 300 index is up 1.2 per cent, with the French market a rare example of a larger gain; CAC 40 index up 5.7 per cent.

What about emerging markets?

Until very recently, the emerging markets had been handily outperforming their developed economy counterparts, but they have faltered in recent weeks, with the MSCI Emerging Markets up only 0.7 per cent in the emerging markets’ currencies and making a 1.8 per cent loss in US dollars. Investors who stayed in the key BRIC markets of Brazil, Russia, India, China, fared relatively well, with the MSCI BRIC index up 0.9 per cent in U.S. dollars, but anyone off the main beaten path ran into trouble.

Two countries in particular suffered big losses: the MSCI Turkey index dropped 25.9 per cent in US dollar terms, and the MSCI Argentina index, strictly speaking classed as a “frontier” rather than “emerging” market, fell by 24.8 per cent. It was a reminder that, while growth prospects are higher, and valuations less expensive, in the emerging markets, they pose their own significant risks.

Other emerging markets to weaken in U.S dollars included Indonesia, down 18.75 per cent, the Philippines, down 15.1 per cent, Poland, down 13.2 per cent, and South Africa, down 10.5 per cent.

The outlook for equities

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The global economic outlook remains solid. As the April JP Morgan Global Composite performance index found: “The start of the second quarter saw a modest acceleration in the rate of expansion of global private sector economic activity. Although growth failed to recover and match the highs seen around the turn of the year, it remained solid and was in line with its long-run trend.”

It helps that the implausible contraction in the global technology sector that had mysteriously shown up in the March data reversed with a bang in April, with the sector having its best performance since September 2014. At the edges there has been the occasional hint growth may not be quite as strong as investors have been expecting.

Eurozone data, in particular, has been on the weaker side of expectations. Japan’s GDP unexpectedly dropped by 0.2 per cent in the March quarter. And the international economists polled in May by the Economist magazine generally tweaked back their forecasts for 2019, other than slightly more upbeat views of Canada and South Africa.

Overall, though, the economic outlook is still a good fundamental base for equity performance. But there are growing risks. The global economic cycle is getting long in the tooth although as both forecasters and fund managers believe, it does not look as if it is going to fall over imminently. In the May BAML fund manager survey mentioned earlier, three-quarters believe equities have not peaked yet. But we are likely to be somewhere down the late stage of a long cycle, where risks of derailment are accumulating.

Global growth slump ahead

In the BAML survey, only 1 per cent favour the idea that the world economy can continue strengthening over the next year, though managers are roughly evenly split over whether the eventual slowdown will happen in 2019 or 2020.

Valuations are also an issue, particularly in the US and particularly, when rising US interest rates are upsetting the previous basis of relative equity valuations. World equity prices have risen by 12.75 per cent in US dollars over the past year, even after the sell-offs in January and March this year.

That reflected a large price response to an acceleration in the world economy which had been given a further nudge along by big tax cuts in the US. But that was then, and this is now, and further gains of that order do not look likely when the odds now suggest an eventual slowdown rather than further unexpectedly good news. The BAML respondents also identified the risks they are most concerned about.

In order, they were potential monetary policy mistakes by either the Fed in the US or the European Central Bank in the eurozone, the fall-out from trade wars, and geopolitical risks that might send the oil price as high as US$100 a barrel. So far, none of those risks has materialised. If anything, the rise thus far of the oil price has helped overall share prices rather than challenged them.

Energy company headwinds

There have been strong gains this year for energy companies; both for conventional oil and gas and for alternative energy. All these torpedoes could yet go on missing their targets, and at the time of writing, the negotiations between the US and China over potential trade concessions had, apparently, staved off at least the immediate threat of trade sanctions.

But realistically world equity markets cannot expect to dodge all the bullets, especially as more of them are being fired by a U.S. administration that has been more comfortable with confrontation, with Iran and North Korea, for example, as well as with China, than previous administrations.

If the global economic cycle were the sole determinant, the equity outlook would be reasonable, though unlikely to match the gains when optimism on growth was at its height. But risks, accidents and politics look as if they could have a spoiling role.

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Peter Gee  is a fund analyst for Morningstar Australia.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

 

 

 

is a fund analyst for Morningstar Australia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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