Global equities: a buying opportunity has materialized, we turn strongly positive
Fundamentals were overshadowed by sentiment; a good buying opportunity has been generated
January 2016 saw the worst start of year memory can recall. The MSCI AC World index lost 6% but had declined by as much as 10% at one point.
Markets have been heavily pummeled since last August by fears about the global economy. Such fears have been driven by a diving oil price and by concerns about a hard landing in China.
A large proportion of investors seem to be unaware that oil demand was rising over 2015 (by 1.7mbd) and that it is expected to keep strengthening over 2016. They completely miss the point that the issue is about supply. Even in China, oil demand expanded over 2015, by 5.7%.
With regards to China, it is true that indicators are contradictory but once they are separated between those that relate to “old China” (investment spending and exports) and those that relate to “new China” (consumption and services), then the picture does not appear that bleak. A focus by China authorities on rebalancing is to be preferred over temptations to stimulate activity like in 2009.
Most leading indicators point to a global economic outlook similar to the one that prevailed last year.
A background of economic expansion, even though clearly unspectacular, is sufficient to build a positive view on stock markets for 2016 because it militates for continued rises in earnings at a time when valuations are absolutely not a constraint.
Discrepancy between sentiment and fundamentals creates a buying opportunity. Given the strong correlation between equity markets, we raise our stance on the asset class from positive to strongly positive, but our key strongly positive views are for the EU and Japan (it is advisable to hedge forex risk). The US keeps our positive opinion because of the late stage of its bull market. On emerging markets we stay neutral, as they have strong support from valuations but their fundamentals keep deteriorating.
A low-return and a more volatile world
We expect mid-single-digit earnings growth in 2016. Last year, earnings stayed flat on a global basis, due to the steep oil price slump. Ex-energy, however, earnings grew at a mid-single-digit pace. This year, the outlook for energy-related sectors remains lacklustre. Hence, the aggregate earnings growth rate that can be expected will be impacted and appear unspectacular. Our main scenario is one of mid-single-digit earnings growth, thanks to sectors such as IT, consumer discretionary and healthcare. Outside the US, earnings growth should prove faster than sales growth thanks to margin expansion. Another positive contribution should come from share buybacks, although this should begin to fade in the US.
In the end, mid-single-digit earnings growth prospects are equivalent to the average growth rate over the long term, which should result in moderate price gains.
Valuations are supportive. With a 12-month forward PE of 14.1, the MSCI AC World index valuation is around its long-term average. With regions such as the euro zone still experiencing cyclically-depressed earnings levels, this is supportive. In addition, the 12-month forward dividend yield stands at 3.2%, which is attractive compared to the less than 1% average for developed government bond yields or the less than 3% offered on global investment-grade corporate bonds.
All in all, we expect returns in 2016 to be driven by the outlook for earnings because valuations will be repressed by uncertainties about the pace of rate hikes in the US, by the multiple sources of political concerns and by the incapacity of the global economy to reach higher levels of growth rates due to the structural constraints brought by the debt mountains and lack of rebalancing of global final demand. Volatility is likely to remain a key feature of markets going forward, among others because of widespread political uncertainties.
An opportunistic upgrade to strongly positive, centered on the EU and Japan; 2016 price gains most likely to be single-digit
In a world expected to offer limited earnings growth, where valuations are attractive but at the same time are unlikely to rise significantly, investors should keep their expectations moderate. They should pay attention to the contribution of dividends.
We like the euro zone because its economy is recovering, its monetary policy is ultra-accommodative and is likely to become even more so, its fiscal policy has turned from a headwind to a backwind. In addition, earnings are still at depressed levels and valuations are attractive.
We like Japan because its fundamental top-down story – Abenomics – remains intact and because it is also a bottom-up story, with the focus of corporate executives on shareholder value creation. The latter is reflected in rising ROEs, which back rises in valuations, and in expanding payout ratios as well as share buybacks. Finally, M&A activity should increase.