We assess the outlook for Europe, the US, Japan, Asia-Pacific and Emerging Markets, outlining the bull and bear cases for investing, and suggesting passive plays.
Mixed views on value in Europe.
Europe was characterised by weak economic growth in 2019. Thanks to general global economic weakness, Europe’s economy – particularly that of Germany – hovered on the edge of recession, prompting the European Central Bank (ECB) to cut rates.
The question for 2020, then, is will this broad economic weakness persist? According to Marion Amiot, senior economist at S&P Global Ratings: “The year 2020 should be another year of below potential growth for the eurozone, but not one of recession.”
Amiot points out that while the latest data suggests the industrial slump that has been dragging down Europe’s economy might be bottoming out, investors should not expect a sharp rebound anytime soon. She warns that Europe’s industrial sector will still suffer from meagre external demand: “Trade tensions will continue to be a barrier to trade globally, while the slowdown of the Chinese and US economies mean import demand for European goods will remain subdued.”
With monetary policy in Europe reactivated, there is a growing consensus that the missing piece of the puzzle for reviving the European economy is increased fiscal spending. However, according to Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers, Europe will see limited fiscal spending increases – “just enough to keep growth afloat, but still far short of what is required”.
He continues: “Despite talk of Germany changing its fiscal stance, we note that key policymakers have implied fiscal easing is unlikely, as they reiterated the need for balanced budgets and strong labour markets.”
In a similar vein, Jim Leaviss, head of M&G’s wholesale fixed income team, notes that while Germany will increase spend- ing, it will likely be at a disappointing level. Leaviss says that stimulus will continue to come from the ECB.
Europe still cheap?
Europe has been tipped as cheap for several years now. But despite the depressing macroeconomic backdrop in 2019, European equities still, broadly, performed relatively well in 2019. The FTSE Europe ex UK index has delivered around 18% year to date. So are European stocks still cheap?
Emmanuel Cau, Barclays head of European equity strategy, expects strong performance from European equities in 2020, noting that he has “a tactical preference for Europe versus the US” on valuation grounds.
Not everyone agrees, however. According to a recent report by Cross Asset Solutions, European equities are now approaching expensive territory. The report states: “The Eurostoxx index has now reached its 81st percentile: European stocks are no longer cheap and have now reached the valuation danger zone, similar to US stocks. Only emerging market and Japanese stocks remain cheap, with limited expected earnings growth.”
Tristan Hanson, fund manager of the M&G Global Target Return fund, observes that some of the cheapest stocks in Europe are banks and cyclicals. When it comes to banks, there is still deep pessimism in Europe surrounding the economy; as a result rates could go lower. This, Hanson says, would be a headwind for European banks. But he notes that bank stocks are currently yielding an average 6%, which means they could potentially surprise on the upside.
In terms of regions and sectors, Amiot believes that economic growth in France and Spain will be stronger than in the rest of the eurozone. This comes back to her point about a lack of external demand for Europe’s manufacturing products given the current macro backdrop. She points out that France and Spain, in comparison to Italy and Germany, have much more service-oriented economies, somewhat insulating them from the weakness of the global economy.
European bond yields converging
Bull case: Europe’s economy is able to keep growing, albeit slowly, with European equities catching up in terms of valuations.
Bear case: After a decent year, European equities are already richly valued while economic conditions are unsupportive of further growth.
Passive plays: how to buy the region
1) To avoid the European industrials being badly affected by the current global slump, opt for the SPDR MSCI Europe Consumer Discretionary ETF, which tracks consumer brands.
2) However, those expecting a value rally in Europe might favour the iShares Edge MSCI Europe Value Factor UCITS ETF, which charges 0.25%, relatively cheap for a ‘smart beta’ vehicle.
US economic growth continues into 2020, representing the longest expansion on record. But what’s the market outlook this election year?
As we enter 2020, two big questions hang over US markets: can the US economy keep growing, and what will happen in the coming US presidential election?
The US economy continued its longest expansion on record into 2019, raising the prospect of the party soon coming to an end. However, many pundits think the run still has some life left in it.
Grant Bowers, portfolio manager at Franklin Equity Group, expects strong growth in 2020. He says he does not see any classic signs that a recession is on the horizon. Moreover, he reminds investors that while the expansion has been a long one, it has been modest compared with previous periods of economic growth.
Similarly, Keith Balmer, a member of BMO’s multi-asset investment team, believes the US economy should hold up, thanks to US Federal Reserve rate cuts in 2019. He admits that economic growth has slowed, but adds: “We are more optimistic, and note the dramatic easing in financial conditions in a country where the transmission mechanism is alive and well.”
Other commentators are not so bullish, however. Ariel Bezalel, head of strategy for fixed income at Jupiter, points out that a recent survey found half of chief financial officers in the US expect a recession by November 2020. That could be a self-fulfilling prophecy, with companies cutting back on investing on the back of such warnings.
Will continuing growth support a continuation of the bull market? According to Arno Lawrenz, global head of multi-asset strategy at Ashburton Investments, even if fiscal and monetary policy are able to keep the US economy chugging along, the potential upside for US equities is now limited.
He points out that in the US the 10-year cyclically adjusted price/earnings (p/e) ratio for the S&P 500 index remains in lofty territory, at more than 30 times – bearing in mind that the long-term average is 16 times. Lawrenz says: “Absent a significantly strong surge in corporate profitability, we cannot argue for an overly positive outlook on returns.”
Eoin Maher, a fundamental analyst of US equities at Unigestion, says that a continuation of economic growth could see a “rotation to value” in US stocks. He adds: “If we see further economic stabilisation, it is likely that value-orientated stocks will play catch-up with their growth counterparts, given the valuation discrepancy between the two. But an improvement in some of the key leading indicators will be required before investors believe the trade has legs.”
All eyes on US election
The 2020 US election could derail US markets. Maher warns: “Political noise in general may well cap the broader market’s p/e valuation in 2020, especially given the fact that the market is not cheap on traditional metrics.”
Certain sectors are particularly at risk. Maher adds: “Anti-trust issues in the technology sector may also raise their heads again as the politicians go head to head competing for votes.”
Stuart Cox, manager of the Jupiter North American Income fund, identifies health- care stocks as also potentially hitting trouble. He says: “High on the agendas of both US political parties are policies to address healthcare costs for states and individuals. The equity market has already discounted some risks, as evidenced by the healthcare sector being one of the worst-performing sectors in 2019.”
Cox also suggests that US banking stocks could come under threat should the Democrats look likely to increase financial regulation – a distinct possibility if Elizabeth Warren wins the Democratic Party nomination. “A Democratic Party policy to reverse Trump’s 2018 tax cut would likely weigh on bank shares,” he says.
Price/earnings divergence a worry
Bull case: The US economy is still broadly in good shape, which should support markets as a whole.
Bear case: US election rhetoric could shift sentiment on key sectors such as technology and healthcare.
Passive plays: how to buy the region
1) BlackRock’s iShares S&P 500 ETF has an OCF of just 0.07%, which is cheap by any standard. The Invesco S&P 500 ETF is even cheaper, at 0.05%.
2) For those who think more cheaply valued stocks may out-perform in 2020, iShares S&P 500 Value ETF is an option, on a slightly higher 0.13% charge.
The Olympics effect may well have run its course, but value opportunities remain in the region.
Japanese companies’ attitudes towards shareholder remuneration are still improving. However, 2020 could see Japan’s highly cyclical market fall victim to a global economic slowdown.
Dan Carter, fund manager of the Jupiter Japan Income fund, says: “Get ready for Olympics fever, as Tokyo hosts this pinnacle of sporting competition for the first time since 1964.” He adds, however, that the time to invest in the Olympics theme in Japan is long past. Instead, the big draw for investors in 2020 will be the continued “realisation of huge latent corporate value”.
Historically, Japanese companies have not prioritised shareholder value. In the past this made for impressive levels of capital spending, but in recent years corporate balance sheets have ballooned as companies have sat on their cash.
This is changing on several fronts, with shareholder value becoming more important for Japan plc. Carter says: “Both private equity companies and activist investors are scenting opportunity, while Japanese companies are taking matters in hand by buying up their own shares in quantities not seen before.” Share buybacks are now at record levels in Japan.
However, the continuation of this trend is not a given. Despite previous government support for corporate governance reform, political risk has emerged. The Japanese government is currently attempting to protect strategic corporate assets, particularly those with leading technology, from what it sees as predatory foreign buyers by tightening foreign ownership laws.
Carter says: “The government must tread carefully to ensure that the potential for a rise in mergers and acquisitions as well as action from activist investors is not hamstrung by red tape.”
Keith Balmer, a multi-asset team member at BMO Global Asset Management, notes that “large sections of the market are still resisting change”.
The big risk for Japan in 2020, however, is the slowing global economy. Nicholas Weindling, portfolio manager of the JPMorgan Japanese investment trust, says: “Given that the Japanese market is more cyclical than other developed markets, it is particularly affected by global economic developments such as slowing global growth and trade disputes.”
Balmer also cites the slowing global economy as a potential risk. “The recently announced fiscal expansion will be critical to maintaining domestic demand,” he says.
Stefanie Mollin-Elliott, a Japanese equities analyst at Unigestion, is slightly more pessimistic. She says: “Fiscal and monetary support should stabilise the economy, but this will not be sufficient to propel the country into the same league as Europe and the US, where 1% and 2% respectively of economic growth is expected.”
Should the global economy continue to deteriorate, Weindling says that the large, cyclical companies that dominate the Japanese market will be hit hardest. He suggests investors “take a fresh approach, instead, by looking at growing companies with a strong foothold in important new sectors globally”.
He cites as examples of such companies cosmetic business Shiseido and clothes manufacturer Fast Retailing (which owns the Uniqlo brand). “Companies such as these offer potentially huge opportunities for long-term investors by providing access to a large and as yet largely untapped mar- ket,” he says.
Meanwhile, Mollin-Elliott likes producers of labour-saving equipment. She says: “There is an opportunity for industrial companies to capture structural demand related to factory automation and labour-saving investment.” She notes that factors such as labour shortages and age- ing populations will drive demand for such technologies.
Japanese firms have plenty of cash
Note: Financial year (FY) ends 31 March of following year. FY2019 figure is latest filing. Source: Bloomberg
Bull case: Japanese companies are likely to continue to place more emphasis on shareholder value and corporate governance, resulting in increased shareholder remuneration.
Bear case: The highly cyclical Japanese market is likely to underperform as the global economy continues to deteriorate.
Passive plays: how to buy the region
1) The most obvious passive route into Japan is the iShares MSCI Japan ETF. However, this would give investors a high level of exposure to the cyclical, export-orientated stocks that weaken in a global downturn.
2) To gain exposure to smaller and more domestically focused companies, investors could go for the iShares MSCI Japan Small Cap Index as an alternative.
Many Asia-Pacific companies stand to benefit from the roll-out of 5G telecommunications technology, despite faltering growth in China.
If China can keep its economy on track, the Asia-Pacific region should deliver decent performance in 2020. In particular, the region should benefit from the rollout of 5G technology around the world.
The fortunes of Asia-Pacific rest largely on those of China. Keith Balmer at BMO says: “This is a diverse group of countries, but they share a common sensitivity to the secular growth slowdown in China.”
So what’s happening with China’s economy? China is seeing its slowest rate of growth in decades. Partly this is the result of the trade war. However, many experts argue that the slowdown has largely been engineered by China’s government in a bid to move China away from an investment-led growth model to a consumption-led one, and to reduce the country’s soaring debt.
The government is aware of the risks in the transition, according to Will Lam, co-head of Asian and emerging market equities at Invesco. He says: “Central government appears committed to stabilising the economy, but it remains conscious of the need to shore up growth while avoiding the large-scale credit-fuelled stimulus that flooded the system in 2009.”
Achieving this balance, avoiding both a sharp slowdown in growth and excessive stimulus, is becoming a more delicate task. However, if China can sustain growth, the broader Asia-Pacific region should benefit.
According to Lam, should the economy slow more than expected, the Chinese government has plenty of firepower to get things going again. He says that so far stimulus measures have been moderate. He adds: “Should trade conditions worsen, central government has the ability to push through targeted fiscal and monetary stimulus measures in order to cushion growth.”
Not everyone shares his optimism, however. Ariel Bezalel, head of strategy for fixed income at Jupiter, believes China now has limited capacity to act. He says: “Officials in China have made it clear that aggressive easing of policy is not on the table. The country already has high debt levels and an inflated property market, and each round of stimulus since 2008 has been less and less effective at boosting the economy.”
Whichever way China’s economy goes, Asia-Pacific faces internal geopolitical risks. Lam says: “Recent tensions in the region – notably in Hong Kong – and a growing trade rift between Korea and Japan have put further downside pressure on market sentiment, while the growth out- look remains opaque.” However, he is not too concerned and expects “incrementally better news flow over time”.
Meanwhile, Jason Pidcock, head of strategy for Asian Income at Jupiter, doesn’t see political risk in the region as especially acute. He says: “Political unrest is likely to simmer in Hong Kong, but the region ought to look settled and peaceful compared with the Middle East.”
Looking at sectors, Ross Teverson, head of strategy for emerging markets at Jupiter, tips semiconductor firms. He says: “Shares in semiconductor firms performed well throughout 2019 on the whole, and there is scope for more of the same in 2020.”
He expects a surge in demand as China rolls out 5G and notes that the industry is well-positioned to profit from change.
Semi-conductor revenue by region
Bull case: Demand for semiconductors is likely to surge as China rolls out 5G. Asia-Pacific should benefit as home to the world’s leading semiconductor firms.
Bear case: If China’s economic growth stalls, so too will the economies and markets of the Asia-Pacific region.
Passive plays: how to buy the region
1) For those who want to buy into the Asia-Pacific region but exclude emerging Asia, one option is the Vanguard FTSE Developed Asia Pacific ex Japan ETF. This has a heavy weighting towards Australia, Korea and Hong Kong. The focus on “developed” economies, however, means Taiwan is not included.
2) Those seeking broader exposure could opt for L&G Asia Pacific Ex Japan Equity Index. This fund includes an 18% exposure to Taiwan, as well as a small weighting to less developed markets such as Thailand and Malaysia.
The key problems emerging markets faced in 2019 will continue, but central bank interest rate cuts should provide support for investment returns.
Emerging markets face the same risks in 2020 that they did in 2019: slowing growth, trade tensions and the strong dollar. Thankfully, global monetary policy looks likely to remain supportive.
Emerging markets were stuck in a tug of war during 2019. On one side, the continued strength of the dollar, slowing economic growth and trade tensions weighed on the performance of the region. On the other side, loose monetary policy around the world was broadly supportive.
This dynamic could continue into 2020. According to Austin Forey, portfolio manager of the JPMorgan Emerging Markets Investment Trust, the key problems facing emerging markets in 2019 are likely to remain in play in 2020. However, central banks will continue to provide relief. He says: “It appears central banks globally are in a full-blown easing cycle, which may offset these risks. Over the past six months key emerging and developed market central banks have cut interest rates a cumulative 37 times, a number larger than at any time in the past decade.”
Other experts also expect continued easing from central banks to provide emerging market support. For example, Luca Paolini, chief strategist at Pictet Asset Management, is most optimistic. He says: “As central banks are opening the liquidity tap again, there’s a sense that sunnier skies are opening behind the recent global gloom. Prospects for emerging market equity and debt are brightening again.”
Sam Vecht, co-manager of the BlackRock Frontiers Investment Trust, also argues that monetary policy should relieve emerging markets, even if macroeconomic head- winds persist. He says: “Given the big liquidity improvement, we expect flows and investments to return to emerging market equities, despite the macro volatility.”
Emerging markets, however, comprise a disparate group of countries whose equity markets often move up or down for their own idiosyncratic reasons. With this in mind, Alexandre Marquis, head of client portfolio management at asset manager Unigestion, believes India will perform strongly in 2020, particularly if the simmering global trade war escalates, harming other emerging economies.
Marquis says: “We believe India remains less exposed to the risk of trade war, thanks to its domestic economy. [At the same time], recently announced stimulus measures should support its economy.”
Ross Teverson, head of strategy for emerging markets at Jupiter, tips Mexico as a potential hot spot for 2020. The country has had a left-wing, populist president over the past year, so it has been out of favour among investors. This has made Mexican equities attractively cheap, with valuations now near the bottom of their historic range.
However, Teverson argues that the outlook for Mexico is far better than forecast. He says: “The political backdrop is more benign than many feared, and the economy is benefiting from firms relocating their manufacturing activities to Mexico as they diversify operations away from China.”
In terms of sectors, he is keen on small banks in smaller emerging and frontier markets, such as KCB in Kenya. He says many banks in emerging markets are able to “combine the strengths of traditional deposit-taking retail banks with fintech-like innovation, allowing them to reach new clients with new products in new ways. This positions them well to benefit from rising financial inclusion, which he sees as a significant structural change in these markets.”
Still playing catch-up
Notes: EM = emerging markets. DM = developed markets. Source: Global GDP data from IMF for 2019, as at October 2019. Global equity markets data from FactSet, as at November 2019. Global debt markets data from BIS, as at November 2019, latest available data.
Bull case: Global central bank easing should continue to support emerging markets, whatever the outcome of the trade war.
Bear case: Emerging markets still face substantial risks, including slowing economic growth, a strong US dollar and the potential for rising political and trade tensions.
Passive plays: how to buy the region
1) One of the most popular ways to buy into emerging markets is via the Vanguard FTSE Emerging Markets UCITS ETF, which has a low fee of 0.2%.
2) That, however, will expose investors to many ‘old economy’ businesses in emerging markets, such as energy and financial companies. Investors hoping to benefit from the emerging market consumer growth story could instead consider the iShares MSCI EM Consumer Growth UCITS ETF, which tracks companies that derive either high or growing revenues from emerging markets.