Internationally speaking, a little caution may be merited

11-20-2018

Slowing growth, falling exports and rising political uncertainty are clouding the near-term international outlook, particularly in export-oriented countries where tariffs and the trade war are starting to bite. The impact varies across developed and emerging markets. Here’s a closer look at key markets:

  • Eurozone European GDP growth continues to run above its 10-year median, supported by consumer spending. But growth has fallen off over the course of the year and could worsen into 2019 on falling exports coupled with political instability in Italy and U.K.’s ongoing Brexit struggles. The European Central Bank has indicated it’s committed to concluding its tapering program by year-end, an action we view as a long-run positive as it eventually will normalize interest rates. But if the economic news continues to surprise to the downside, we worry this nascent movement toward rate normalization may be put off again. Still, from an investment perspective, eurozone corporate earnings and valuations remain attractive relative to the U.S., with price-to-book ratios near historic lows compared to the U.S.
  • U.K. Negotiations for its exit from the European Union (EU) next March are complicated by history, cultures and sovereign issues. As always, it’s likely to come down to the last minute before the two sides come to an agreement, assuming Prime Minister Theresa May can win approval at home—no small task. In the end, we think the U.K.-EU relationship won’t look much different from what it is now. The U.K. likely will have a little more control over its markets and immigration, but customs and trade agreements will not be altered significantly. This could be a good thing for Britain. The bigger issue would be if other EU member states such as Italy think they, too, can exit with little consequence. Then the EU will be forced to hold a harder line and all bets are off. Stay tuned.
  • Japan Trade wars and the slowdown in China has started to weigh on Japan’s growth, though at 2.4%, its unemployment rate remains the lowest in the world. Higher corporate profits also are driving a revival in business spending. While we are concerned longer term about the potential negative impact of a planned October 2019 consumption tax increase, in the short term, this could prove stimulative as people tend to buy ahead of tax increase.
  • Emerging markets (EM) While we believe most of the bad news has been priced into EM equities, creating potential selective buying opportunities, the EM remains our biggest area of concern. Dollar strength and a slowing China represent strong headwinds. We are just starting to see the impact of the U.S.-China trade war on China’s growth, both in exports and investment. Many companies are looking to move their manufacturing out of China to avoid the U.S. tariffs, particularly the much harsher round that kicks in at the start of 2019 if the two sides fail to reach some sort of an accord.

The bottom line In spite of the overall uncertainty, the fundamental international story remains intact. Earnings are growing, valuations are attractive and dividend yields are high. Relative returns ratios between the U.S. and the rest of the world are near November 2016’s historic highs. That said, we have turned a bit more negative on the global markets as we await greater clarity around the geopolitical issues negatively impacting stock prices. We except to get that soon, hopefully in a positive manner that will allow fundamentals return as the key driver of returns. If we get that, we believe global markets should move higher.