3 indications that non-U.S. stock markets can be great again under Trump

Non-US stock markets

By: Jon Eggins, Senior Portfolio Manager, Global Equity
Paul Eitelman, Investment Strategist

In the month since the U.S. election, the S&P 500® Index has rallied 5%, outpacing European (MSCI Europe Index) and emerging markets (Russell Emerging Markets Index) in U.S.-Dollar terms. The prospect of a post-Trump fiscal stimulus package and concerns about the impact to non-U.S. markets of rising protectionism on both sides of the Atlantic has led to forecasts that U.S. assets are poised for a run of outperformance.

We think these expectations are overly optimistic. Instead, we continue to see value in non-U.S. equities despite their recent underperformance and believe that U.S. equities may have over-shot based on fundamentals.

Let us explain.

Non-U.S. equity market outlook

  1. Geopolitical risk has risen, but is unlikely to derail the European expansion. Absent a populist upset for Marine Le Pen in France in early 2017, Trump’s victory doesn’t have a meaningful impact on our cyclical outlook for non-U.S. developed markets. His nationalist strategy, is mostly targeted against China and Mexico. Europe isn’t in the cross-hairs, and could actually benefit if fiscal stimulus boosts U.S. growth. Nevertheless, trade wars are a risk to the global expansion.
  2. Fiscal stimulus in the U.S. may boost growth, but a rising dollar helps Japan and Europe. Trump’s plan to inject more growth into the U.S. economy should nudge inflation upward. This makes it easier for the U.S. Federal Reserve to hike interest rates and the 10-year Treasury yield has already shot up to 2.4% in recent weeks (as of Dec. 8), a full percentage point increase from where it stood in July. This affects global markets, especially Japan, where the central bank is pegging the 10-year Japanese Government Bond yield at 0%. The widening interest rate differential has led to a stronger U.S. dollar – a headwind for U.S. multinational companies’ profitability and a tailwind for similar businesses in Europe and Japan. As a result, Japan actually outperformed the U.S. (S&P 500 Index) in local currency terms in November and the fourth quarter-to-date (as of Dec. 7), with the Tokyo Stock Price Index up approximately 9% in local currency terms between Nov. 8 and Dec 7.
  3. Non-U.S. fundamentals are solid. Cutting through the political noise, we have seen a fundamental improvement in non-U.S. markets. According to the Markit Eurozone Composite PMI, Europe shrugged off the Brexit vote with leading economic indicators at an 11-month high in November, and the region showed stronger earnings growth and profit margins in the third quarter. The Bank of Japan has effectively committed to finance government spending with a 0% 10-year yield target and a major fiscal program could be a positive game changer.

Our conclusions:

  • CycleNeutral (but on upgrade watch). The advent of economic populism is a tail risk for the European currency union but economic and earnings fundamentals have improved.
  • ValuationAttractive. Euro zone and Japanese equities are slightly cheap in an absolute sense and outright cheap relative to the U.S.
  • Sentiment – Neutral. Price momentum is roughly flat in Europe and Japan. Markets are starting to swing into a euphoria phase but those concerns are more pronounced in the U.S.

U.S. equity market outlook

  1. Injecting stimulus into an economy near full capacity may fan the flames of inflation. Rising labor costs are already one of the biggest obstacles for the U.S. earnings outlook and fiscal stimulus could exacerbate the pressure on profit margins.
  2. The U.S. equity market is already expensive. One of the rationalizations for high valuation multiples was that interest rates were low. But with the 10-year U.S. Treasury yield now up to 2.4% (as of Dec. 2) post-Trump, these higher discount rates pose a more meaningful headwind to the U.S. market.
  3. Intra-market performance has varied quite strongly since the election. Those parts of the U.S. equity market that benefit from higher interest rates and more fiscal stimulus have been outperforming other sectors: For example, in the month of November alone the S&P 500® Index Financials sector outperformed the S&P 500® Index Utilities sector by nearly 20 percentage points. Looking forward, we continue to see more upside in Value stocks than expensive Low Volatility stocks as U.S. interest rates rise.
  4. The dollar appreciated on the election outcome and now stands at its highest level since 2003. Dollar strength acts as a speed brake on the economy (by hampering exports). According to our research, recent currency moves could also subtract 1.5 percentage points from S&P 500® Index earnings growth in 2017.

Bottom line:

We continue to prefer non-U.S. developed equity markets in global portfolios, primarily on the back of their attractive valuations. Within both the U.S. and non-U.S. equity markets, we prefer Value factors to the expensive, seemingly defensive market segments.

Disclosures:

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than US and longer-established non-US markets.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

The Russell logo is a trademark and service mark of Russell Investments.

Copyright © Russell Investments Group, LLC 2016. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

Russell Investments Financial Services, LLC, member FINRA (www.finra.org), part of Russell Investments.

RIFIS: 18129

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