Perinvest Q2 2019 Review and Outlook

Q2 started where Q1 left off – with markets rising ever higher. The S&P 500 finished April up 4.1% while the MSCI Europe rose 3.8%. Markets fell sharply in May as Trump threatened to continue his trade war with China. The S&P 500 fell -6.4% while the MSCI Asia ex-Japan dropped -8.5%. June saw markets reverse their May losses as the world central banks hinted that they will loosen monetary policy. The S&P 500 rose 7.1% in June while the MSCI Asia ex-Japan gained 6.7%.

Looking forward, much will depend on two factors: monetary policy and trade wars. With reference to the latter, the Fed is in the midst of the “Powell pivot” with the Fed turning its policy from hawkish to dovish by signalling that it plans to cut interest rates later this month. This comes as wages are rising, the stock market is at record highs, unemployment is under 4% and inflation is close to target (core PCE is at 1.7%). This could cause a stock melt-up; however, bourses could fall if the Fed fails to deliver what the market expects. On the negative side, cutting interest rates could cause Trump to have a more aggressive stance in trade negotiations. Threats to raise tariffs on China have caused the world economy to slow and he is now intimidating India, Vietnam and the EU.

The TOPIX was down -2.5% in Q2 and trades on a P/B of 1.2 and dividend yield of 2.5% - the latter being close to the levels of emerging markets and other Asian stocks and all with Japan maintaining negative interest rates. The cash yield of the market is above 5% while the earnings’ yield is at highs last seen in the 1970’s. Over the last year, Japanese firms returned 67% of their profits to shareholders. Like much of the world, there is a large divergence between value and growth stocks with the P/B for value stocks at the same level as it was in 2008. The top decile of the 2,000 largest stocks trading at a P/B ratio 9 times that of the cheapest decile while the corresponding figure the largest 400 firms is 6.2. 23% of Japanese stocks trade on a P/E below 10.

Asia ex-Japan trades on a dividend yield of 2.6% and a modest P/B of 1.6x. China recently produced one of its lowest quarterly growth rates at 6.2% (still impressive by global standards). Despite this, consumer confidence in the country is at record highs. Chinese firms should be boosted by improved revenue growth and operating margins in the coming months. In India, a win for the ruling BJP party could lead to further economic reforms helping increase economic growth Any resolution to the US-China trade war should help regional economic growth and bourses.

US stocks trade on a P/E of 20x, dividend yield of 1.9%, and P/B of 3.5x. The stock market should benefit from the Fed’s sudden dovish tilt; however, it could lead to Donald Trump becoming more aggressive in his trade spat with other global economies. Also, earnings growth is expected to be anaemic although positive surprises could help boost the market. The P/E valuation spread between growth and momentum stocks remains significantly above its historical average with the top quintile P/E less lowest quintile forward P/E at 15 versus an average of 9.

European markets look enticing with the MSCI Europe paying a dividend yield of 3.8% and trading on a P/B of 1.8x. Wages are rising in the Eurozone while unemployment is falling. On the negative side, the economy is slowing with talk growing that the ECB is planning further easing as core CPI remains around 1%. Any improvement in global trade will help the region given its large export sector; however, there are concerns that Donald Trump may start a trade war with Europe. Any positive developments in the Brexit saga should help the region.

Emerging Markets performed decently in Q2 rising 0.6%. They trade on a P/B of 1.6x and dividend yield of 2.8%. On a normalised P/E basis, emerging market stocks trade at a 38% discount to developed market ones. The region should benefit from a weakening USD which should help growth and reduce foreign debt burden. In addition, correlations between EM and DM have gone down from highs in the late noughties of 0.9 to around 0.7 now. This should help stock dispersion and increase the benefits of portfolio diversification.