April saw markets come back after a volatile previous two months. Developed markets outside the US saw the biggest bounce with the TOPIX and the MSCI Europe up 3.6% and 2.8%, respectively. May and June saw the S&P 500 up 3% as the corporate results came in strong and the Fed signalled a strong outlook for the US economy. However, markets outside the US (especially emerging ones) weakened during that time as Trump started a trade war with all of America’s major economic partners (China, Canada, Mexico and the EU). This combined with rising interest rates and the shrinking of the Fed’s balance sheet led to a strengthening of the US dollar. This hit emerging markets with the main MSCI index for it falling just over 6% in the last two months. Also, the ECB announced it will end bond purchases by the end of the year. However, this “dovish tightening” led the Euro to fall 5% as Mario Draghi stated that interest rates will not rise until summer next year.
Looking forward, the global economy should continue growing; however, there are clouds on the horizon. The Fed is expected to raise interest rates to 2.5% by the end of this year while its balance sheet will shrink by $40bn a month this quarter and $50bn a month next quarter. Trump’s threat of a trade war could slow EM growth and lead to continued deprecation of currencies in that block. Also, there is speculation that the BOJ may end its yield cap on the 10-year JGBs which could cause world bond yields to rise significantly.
Asia ex-Japan has decent growth prospects with moderate valuations - the MSCI Asia ex-Japan has a dividend yield of 2.6% and a price-to-book ratio (P/B) of 1.5. This makes the market cheaper than it was last quarter. The region has been affected by a potential trade war with the US and depreciation of local currencies; however, a lot of bad news has been priced in and the area is still witnessing strong fundamentals.
Japan looks cheap with the TOPIX trading on a P/B ratio of 1.3 while the normalised P/E is near the bottom of the last 45 years’ range. The TOPIX 100 has a P/E of 12. 2017 will be the 6th year of profits’ growth in the country. This is the longest streak in the country’s post war history. Also there is a big divergence within the stock market as 16% of Japanese stocks have a P/E lower than 10 and 19% have a P/E higher than 30.
European equities look reasonably priced with the MSCI Europe trading on P/B of 1.8 and generating a dividend yield of 3.5%. The continent is witnessing decent economic growth with positive figures now coming from all regions. PMI figures have come in weaker than last year, but are still strong. The market has come to terms with a populist government in Italy.
US markets are fairly valued. The S&P 500, as a whole, trades on a P/E of 21 whilst it pays a dividend yield of 1.9% and has a P/B ratio of 3.1. The market is balancing two counteracting forces – on one hand the economy is growing strongly and profit growth is strong on the other hand monetary conditions are tightening and a global trade war could dent growth.
The MSCI EM Index trades on a dividend yield of 2.7% and P/B of 1.6. This is cheaper than last quarter. The region has suffered from the strength of the USD, withdrawal of global liquidity and Trump’s trade threats. That said, fundamentals for this part of the world are still strong.
One issue which we have previously mentioned is the large divergence between growth stocks and value ones. The discrepancy between the two is approaching levels last seen during the dotcom bubble and appears in most regions we monitor.