Emerging markets should continue to fare better in terms of economic activity in 2015 and 2016 than their mature counterparts. Nevertheless, the deviation in growth rates between the two is projected to narrow somewhat from prior years. China’s economic momentum is expected to hold near seven percent this year before slipping to 6.8 percent in 2016, still a respectable rate of advance by comparison with the rest of the world.
Meanwhile, disinflationary pressures are unlikely to abate in the immediate future as some Asian nations (like Singapore, Thailand and Taiwan) flirt with deflation, while other developing countries (such as, Brazil) suffer from ongoing stagflation (rising living costs accompanied by ebbing economic growth). In light of the outlook for the global economy, our strategy maintains overweighting domestic shares at the expense of stock markets abroad and retaining across-the-board neutrality in fixed income investments.
Divergences in monetary policies among developed and emerging economies appear likely to persist for the foreseeable future. The Federal Reserve and the Bank of England are expected to refrain from increasing their key policy rates until a sustained rise in nominal labor costs is deemed threatening to their respective target rates. The European Central Bank, meantime, will adhere to its policy posture of aggressively relaxing credit conditions as it awaits a change in the direction of living cost trends from a declining to rising direction. In Latin America, central banks will continue to tighten credit in an effort to restrain inflationary pressures. Monetary authorities in Asia are split between relaxation and tightening depending on their economic circumstances.
Rebuff Aussie and Canadian Stocks in Favor of US and Kiwi Markets
Anticipated tepid macroeconomic growth in Australia and Canada, coupled with exceptionally high one-year forward price/earnings multiples (p/e) of equal to or fractionally greater than their twenty-year historical averages (15.1x and 16.7x, respectively), argue for underweighting stocks of both the Sydney and Toronto stock exchanges in the period immediately ahead. Unlike Australia and Canada, however, the US and New Zealand seem to offer varying opportunities to the upside due to relatively stronger expectations economically although their current p/e ratios exceed their corresponding twenty-year historical means of 18.0x and 15.6x and their credit stances have become restrictive (NZ) or are on a path toward normalization (US).
Only British and German Equity Markets Merit Over-weights in Europe
The hype surrounding the impact of aggressive credit relaxation implemented by the euro bloc monetary authorities is imparting an unjustifiably impulsive lift to France’s and Italy’s exchanges. Until the euro’s rapid twenty-three percent descent against the US dollar translates into sizable gains in exports, Great Britain and Germany will remain our favorites to outperform in Western Europe this year. Greece’s financial troubles and possible exit from the currency union remains a destabilizing force in the next couple of months. The May 7th UK national elections are also a huge uncertainty since polls indicate the likelihood of a setback to the Conservative party. Still, UK and German economic outperformance favor shares of the London and Frankfurt bourses.
Japan’s Muted 2015-16 Economic Outlook Still Earns an Under-weight
Nothing, other than a surge in speculative appetites of risk-eager investors, can possibly explain the double-digit US dollar returns of Japanese shares markets so far this year, in our opinion. In line with the concerns of Bank of Japan Governor Kuroda – who sees the economy facing the threat of a relapse into deflation, the Nikkei 225 is undeserving of such capital inflows from the outset of 2015 since they do not correspond with a comparable improvement in domestic economic fundamentals. The third arrow of Prime Minister Shinzo Abe’s eponymous economic rejuvenation program will take years, if not decades, to come to fruition. In the meantime, in our opinion, investors should under-weight Tokyo until the economy displays sustainable strength.
Discerning Emerging Market Investment Opportunities Still Available
For risk-avid investors in search of idiosyncratic equity investment alternatives, all three regions of the emerging world – Asia, Latin America and Central and Eastern Europe, Middle East and Africa (CEEMEA) – still offer a measure of diversification provided such market participants are fully cognizant of all the risks. Divergences in economic patterns of developing countries should persist for the predictable future, rendering a logically compelling rationale for a discriminating strategy to invest in emerging stock markets. Incongruences in forecast economic growth rates nationally and regionally through 2016 distinguishes over- from under- and market-emphases. Among frontier markets, Panama poses a long-term opportunity with significant upside potential.
Directionally dissimilar policymaking postures and generally asymmetric macroeconomic trends segregate those emerging Asian shares markets worthy of an over-weight from those meriting either market-neutrality or an under-emphasis. A loftier economic outlook merits China, India, Taiwan, Philippines and South Korea over-weights. Indonesia’s murkier timetable for executing further reforms, apart from what little it has achieved so far, earns it (like Singapore, Hong Kong and Malaysia) market neutrality. Military rule in Bangkok assigns Thailand an under-emphasis.
Conflicting policymaking climates and disharmonious projected rates of macroeconomic growth across Latin America distinguish precisely which markets in the region will tend to out- or under-perform during the course of this year and next. Better economic prospects confer over-weights on Mexico and Colombia. Policy opacity and economic debility keep Chile and Peru in neutral. Brazil, Venezuela, Ecuador and Argentina stay under-emphasized due to economic instability.
Distinctive variations in the direction of policymaking and differing patterns of macroeconomic activity retain Poland, Hungary and Israel as the only CEEMEA shares markets meriting over-weights, all of which possess the potential to ascend higher in performance owing to relatively inexpensive p/e valuations. Russia remains an underweight until it incontrovertibly ceases its territorial intrusion in the Baltics and subversion of Eastern Ukraine. Growing authoritarianism confines Turkey to an underweight as labor strife consigns South Africa to an under-emphasis.
Directional Differences in Mature Market Monetary Policies to Persist
The re-establishment of normality to UK and US monetary policies appears out of the question for the months to come as the central banks of both nations maintain a guarded stance against the eventuality of deflation. Under these circumstances, a steepening of yield curves in both the gilt and Treasury debt markets appears highly unlikely in view of the fact that economic growth is projected to underperform their potential rates of expansion. Additional flattening, however, seems inevitable in the short run amid doubts about the urgency to tighten too soon, justifying our recommendation for investing in diversified, high-quality debt instruments of short duration.