Market Memo: International equity outlook remains mostly positive


Federated strategists believe there are a lot of reasons to remain bullish on the international equity markets. Global GDP growth is running well above its 10-year average, with both developed and emerging markets (EM) expanding simultaneously for the first time in years. The global manufacturing PMI recently hit a 6-year high. Leading economic indicators reflect continuing momentum, particularly in developed markets. And inflation is subdued and should remain so through 2019.

Geopolitical events remain the biggest risk, the most notable being North Korea’s nuclear ambitions. While we do not foresee an all-out war, the probability of a costly miscalculation increases greatly as bellicose rhetoric continues to volley between President Trump and North Korea’s Kim Jong Un and missiles continue to fly over Japan and the Korean peninsula.

After reviewing the macro and fundamental environment for the third quarter, the Federated International Outlook Committee also had these thoughts about the following regions:

Eurozone: Positives for economy and equity market
The overall euro-area economy is robust—GDP is expanding in all 27 countries within the European Union (EU), and the region as a whole had its 13th consecutive quarter of growth in Q3. GDP forecasts continue to trend upward, with growth now projected to reach 2.2% for 2017 versus 1.4% at the start of the year. Both manufacturing and service PMIs are in an expansionary mode, reaching an 80-month high in October. Unemployment rates continue to fall, with more than six million new jobs added over the past two years, feeding domestic consumption as evidenced by strength in both retail and auto sales. Near term, the economy’s health is offsetting potential pressures from a strengthening euro.

With growth in the eurozone more established, the focus has shifted to European Central Bank (ECB) tapering of its quantitative-easing program. The central bank recently announced that, starting in 2018, it will cut monthly asset purchases in half, from 60 billion euro to 30 billion euro, while holding interest rates steady. The ECB’s dovish stance—we don’t anticipate it will initiate discussions on potential rate hikes until 2019—coupled with a eurozone banking crisis now in the rearview mirror should be constructive for equity markets and future growth. We do see risks on the horizon as ECB President Mario Draghi’s term ends in 2019, and will be monitoring developments as 2018 unfolds.

In the U.K., the macro environment seems fragile. GDP has slowed to a 4-year low of 1.5% year-over-year (y/y), inflation has increased to a 5-year high of 3% and unemployment is at a 42-year low of 4.3%. Further complicating matters is that inflationary pressures are not demand driven, but rather stem from weak productivity aggravated by Brexit. While it recently increased rates, the Bank of England signaled that future increases will be limited and gradual. With little insight as to what England’s future relationship with the EU will look like, Brexit likely will remain an overhang in the equity market for the foreseeable future, with select cases of value being created.

After a relatively calm period following the election of Emmanuel Macron as France’s president, the geopolitical environment in the eurozone has reemerged as a concern. Progress on Brexit negotiations has been very slow. Catalonia’s independence bid in Spain shows little sign of coming to an acceptable resolution anytime soon. Italy holds elections in 2018. And populist movements are gaining support in Poland, Czech and Hungary. In sum: the potential for euro-area fragmentation could weigh on 2018 growth prospects.

Japan: Economy positive, equity market neutral to positive
Data out of Japan continue to indicate its economy is on solid footing. GDP has been expansionary nine straight quarters. Inflation remains positive, albeit at low levels, as does export growth, private consumption and public spending. Leading Indicators and PMIs reflect a stable growth environment. And the unemployment rate hit an 11-year low of 2.8% in August, with the number of jobs per applicant sitting at a 45-year high. Despite such low joblessness, there is still little sign of meaningful wage inflation. We view this as unsustainable. When combined with a rapidly aging population, low birth rate and closed borders, such low unemployment is almost certain to exert upward pressure on wages, which in turn should further support consumption and expansion.

Concerns over corporate governance returned after Kobe Steel disclosed that management had lied about quality standards over the last 10 years. This, along with other recent scandals such as the airbag cover-up at Takata, may cause investors to remain overly cautious on a region that currently has many positive economic attributes.

Among those positives are Prime Minister Shinzo Abe’s recent election win. It reconfirms his supermajority and pursuit of both “Abenomics” and constitutional reform; increases his chances of winning another 3-year term next September; and boosts odds that Haruhiko Kuroda will serve a second term as head of the Bank of Japan.

EM: Economy neutral; equity market neutral to positive
Emerging markets continue to perform well, with the MSCI Emerging Market Index up 32.3% year-to-date through October. Our preferred regions within the EM are China, India and Brazil.

After ending the first half of the year at solid 6.9% growth, China’s economy showed signs of moderating in the back half of 2017 as government efforts to stabilize the economy and reduce speculation and excess capacity in select sectors created headwinds. However, concerns over a slowdown in industrial production, retail sales and fixed-asset investments at the start of the Q3 eased when manufacturing data picked up midway through the quarter. Leading indicators also suggest growth is gaining momentum, particularly in the industrial sector. PMIs have eased slightly but remain expansionary. October’s National Communist Party Congress further cemented Xi Jinping’s power, supporting ongoing economic and political stability.

In India, summer’s quarterly growth rate slowed to a 3-year low of 5.7% annualized on the back of destocking prior to the July implementation of a new goods and services tax and lingering impacts of December’s 2016’s demonetization. However, both the PMI and OECD leading indicators are signaling upward momentum, abetted by the fastest payroll growth since May 2010. Inflationary pressures—the CPI recently rose 100 basis points to 3.4% y/y—have the Reserve Bank of India standing pat on interest rates.

Following two years of contraction, Brazil’s economy is growing again, with GDP slightly positive for two straight quarters. Leading indicators also portray an economy on the upswing, with PMI surveys signaling the fastest rate of expansion since February 2015. Falling inflation—it hit an 18-year low in August—has allowed the Banco Central Brasil to cut rates throughout the year, from 13.75% at the start of 2017 to 7.5% currently. Potentially overshadowing this budding recovery heading into 2018: lingering political instability linked to ongoing political corruption investigations.