Look to the East
Our international team sees opportunity in China, Asia.
The global economic and equity market outlook remains challenged, with higher inflation, supply chain constraints, the war in Ukraine and China’s Covid policies weighing on GDP and earnings growth. With Q2 earnings season just around the corner, Federated Hermes’ strategists who comprise the International Outlook Committee expect companies to lower full-year 2022 estimates amid declining business and consumer confidence, rising global bond yields (especially among peripheral European countries such as Italy and Greece) and a reversal of decade-long loose monetary policies and quantitative-easing programs by most central banks.
It's not all doom and gloom. PMIs indicate manufacturing and service sectors remain expansionary in much of the world, though the pace is moderating. Holed up for two years, European consumers have unleashed pent-up demand, making for a robust summer. And the committee expects China growth to strengthen as it eases Covid restrictions and, in a break with most central banks, loosens monetary policy to spur activity ahead of this fall’s all-important 20th National Congress. But the drag of higher rates and inflation are almost certain to start to bite as summer fades. Here’s our take on specific regions:
- Eurozone: Negative on the economy, neutral on the equity markets The war in Ukraine, along with an inability to increase production and government regulations, are keeping energy prices extremely high on the continent, making it vulnerable to Putin cutting off the flow of natural gas to the region. European Union members are working hard to fill gas reserves, but any disruption of current flows from Russia could accelerate what appears to be a budding economic recession. With the conflict also cutting off a key source of grains and foodstuffs, food prices are surging. Sovereign spreads have widened, especially among peripheral countries, as investors assess credit risk and the magnitude of a likely recession. On the plus side, unemployment rates are at historical lows (which could pressure annual wage negotiations), household savings rates are solid, eurozone debt to GDP is low enough to allow for additional fiscal stimulus if needed, the EU has been unified by the war and equity valuations are low, reducing the potential for adverse P/E multiple compression.
- U.K.: Negative on the economy, neutral on the equity markets As with the rest of Europe, manufacturing and services PMIs are slowing and nearing contraction as higher inflation and a slowing economy weigh on companies. The Bank of England has been aggressive, raising rates 115 basis points since December, adding further economic headwinds. With almost 80% of revenues of the FTSE 100 coming from outside the country’s borders, a weakening British pound relative to the dollar is making U.K. products more competitive. Also, the FTSE 100’s composition is heavily weighted toward value sectors that our equity teams prefer for their relative outperformance in these volatile markets, with Energy, Consumer Staples, Materials, Industrials and Financials making up 69% of the benchmark. The FTSE 100’s dividend yield of 4.2% also compares favorably to 1.7% for the S&P 500 and 3.6% for the Stoxx 600.
- Emerging Markets: Positive on Asia and neutral on Latin American economies, overweight equities in both With Shanghai reopening and hard lockdowns giving way to more mass (and constant) testing, Covid’s drag is easing in China just as 50 new fiscal stimulus programs launched between March and May are starting to show results. These include relaxing regulatory pressure in the tech sector, holding off an increase in property taxes, lower mortgage rates, cash payments and credits to the consumer, along with securing energy and food supplies. Unlike most central banks, the Peoples Bank of China also is loosening as inflation in Asia remains relatively subdued. Geopolitical risks remain high as China stays supportive of Russia, though Chinese companies have been careful to avoid getting caught up in Western sanctions. With growth forecasts above global averages and currencies relative to the dollar performing better than developed currencies (largely because many EM countries tightened last year), EM Asian equity markets look set to outperform, particularly China, where earnings and valuations have been revised down. EM Latin America equities also should continue to outperform—they’re up double-digits year-to-date—as energy and commodity companies that have ridden the price wave dominate their markets. Pricing increases are an obstacle for consumers. And the back half of the year promises a lot of political theater with a looming presidential election in Brazil, Chile voting on a new constitution in early September and Columbia electing the most left-wing government in its history.