Following the worst December for the S&P 500 since the Great Depression, markets staged one of their strongest comebacks in decades with the S&P 500 rising 8%, the MSCI EM 8.8% and the MSCI Asia ex-Japan 7.3% in January. Markets continued their strong run in February and March albeit a slower pace. A large reason for this uptick was the sudden change in tone form the Federal Reserve. It went from predicting two rate hikes in 2019 to zero and announced that it will end QT at the end of September- this points to the “Fed put” still being in place under Jerome Powell.
Looking forward, market movements will depend on whether there is a genuine slowdown in the world economy or whether it is just temporary. Wages are rising in the US which could cause inflation to rise putting pressure on the Fed to raise interest rates. On the other hand, should the US economy fall into recession corporate profits will suffer. Markets are betting on a Goldilocks outcome where the economy slows to keep inflation low, but not too slow that it creates a recession. Another big item to watch is the US-China trade dispute. Pundits believe that there will be an agreement reached in May. This should provide the markets with a boost and help currencies of economies that depend on foreign trade (EM currencies and the Euro). However, it could lift economic growth to the point where central banks have to raise interest rates as it is the main impediment holding back the global economy.
The TOPIX was up 6.5% in Q1, but still trades on a P/B of 1.2 and dividend yield of 2.4%. The TOPIX 100 (large-cap section of the TOPIX) trades on a P/E of 10 even as profits are rising. The difference between the TOPIX E/P ratio (reverse of P/E) and JGB yields is the highest ever as is the country’s risk premium. Net foreign selling at the end of last year was the highest it has been since 1990. Moreover, Japanese firms are renowned for conservatively forecasting their profits at the beginning of the financial year.
Asia ex-Japan is the fastest growing region in the world and its stock market valuations are quite modest with the MSCI index trading on a dividend yield of 2.5% and P/B of 1.6. Any resolution to the US-China trade spat should help the region’s economies as they are highly geared towards global trade and form a large part of the global supply chain.
US stocks trade on a P/E of 19, dividend yield of 1.9%, and P/B of 3.5. The stock market should benefit the Fed’s sudden dovish tilt. It remains to be seen how much the economy will slow from last year as this affects corporate earnings. A resolution to the US-China trade war should help equity markets, but the Fed could become more hawkish if it results in the economy improving materially.
European markets look enticing with the MSCI Europe paying a dividend yield of 3.8% and trading on a P/B of 1.8. The economy has suffered although the ECB believes this slump is temporary as the service sector is performing well while it is mainly manufacturing that is struggling. The region and its currency should be a huge beneficiary of any resolution to the US China trade war as exports equal 46% of Eurozone GDP and this part of the economy has struggled with slowing world trade. In addition, the region should witness a modest fiscal expansion and rising wages. Italian non-performing loans are falling.
Emerging Markets were one of the best performing regions in Q1 as dovish monetary policy and optimism over global trade helped this region significantly. The MSCI EM rose 9.9% over the last three months. India is having elections that should see Modi’s government return to power. Other countries within the region are undertaking economic reforms which should help boost growth.