July and August saw world markets continue their strong run as strong earnings were reported and economic growth remained resilient. The S&P 500 rose 3.7% and 3.3% during those months while the MSCI World gained 3% and 0.8%. September saw a divergence in performance - US stocks rose while Asian and Emerging Markets fell. The latter fell due to increasing threats of a trade war, depreciating currencies due to monetary tightening and current account deficits, and investors overlooking those markets. One example of market panic was Turkey, where the currency depreciated 28% in a matter of days as investors became concerned about the large current account deficit and felt they were not being compensated for inflation in the country. The central bank raised interest rates to 24% and the currency has since stabilised. In Argentina, fears over inflation and a falling currency forced the central bank to raise interest rates to a whopping 60%. Since, the peso has rallied 10%.
Looking forward, markets will have a lot to digest. In Europe, ECB bond purchases were reduced to €15bn a month and will end in December. The market is pricing in a 75% probability of a rate hike in September 2019. Britain is negotiating its departure from the EU with rumours that a deal could be reached very soon. Should that happen and Theresa May win a parliamentary vote (not a sure thing by any means of the imagination!) the pound should soar. Nervousness over Italy’s expansionary budget should dissipate as it could boost economic growth and is within the budget guidelines of the Eurozone at a deficit of -2.4% (Budget guidelines stress that it should not exceed 3%). In the US, midterm elections happen in November with democrats expected to capture the House of Representatives (although the Republicans should maintain control of the Senate). In this scenario, it is highly likely that gridlock will ensue although some Democrats are supportive of Trump’s trade policies. So far, global markets have witnessed a strong selloff.
Asia ex-Japan has decent growth prospects with moderate valuations - the MSCI Asia ex-Japan has a dividend yield of 2.8% and a price-to-book ratio (P/B) of 1.4. Markets have gotten cheaper over the last quarter due to fears over US trade tariffs. The US recently renegotiated a trade deal with Mexico and Canada and it is possible a deal could be reached with China when Xi Jinping meets with Trump in November.
Japan looks cheap with the TOPIX trading on a P/B ratio of 1.3 and a dividend yield of 2%. 17% of Japanese stocks have a P/E lower than 10 and 18% have a P/E higher than 30. This compares to 10% and 13% for global stocks meaning there are great opportunities for long-short managers and stock pickers. Non-manufacturing gross margins at post war highs while US small business and Asian consumer confidence are at all-time highs which should provide a boost for the country’s exporters.
European equities look reasonably priced with the MSCI Europe trading on P/B of 1.8 and generating a dividend yield of 3.6%. The continent is witnessing decent economic growth with positive figures. Profit growth is expected to be 9% in 2019 – faster than the world as a whole. Capacity utilization is nearing peak levels and there is strong pent-up demand from a decade of underinvestment. A potential exit deal between the EU and the UK could be positive for both.
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 1.8% and has a P/B ratio of 3.5. The country is witnessing strong economic growth economic and corporate profit growth, but interest rates are rising and congressional elections could lead to gridlock.
The MSCI EM Index trades on a dividend yield of 2.8% and P/B of 1.5. 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 and a breakthrough in trade talks between China and Trump could unlock value in the region.