Global Equity Outlook
Second Quarter 2015
- The first quarter of 2015 saw a continued divergence of monetary policy among the world’s central banks. While the U.S. and U.K. released hawkish sentiments about possible interest rate increases, the European Central Bank (ECB) began its long-anticipated quantitative easing (QE) program with €60 billion in sovereign bond purchases. QE continued apace in Japan and China, and central banks in Thailand, India, and South Korea all announced unexpected rate cuts during the quarter. In this environment, stocks were mixed in global markets, with Japan the only clear winner.
- Japan led all other markets in performance, buoyed by ongoing stimulative policies and the resulting weaker yen.
- Europe was also in the black for the quarter after several quarters of underperformance.
- U.S. stocks were mixed for the period overall. Down in January amid disappointing earnings announcements, rebounding in February on upbeat jobs and wage data, but falling again in March. Investors became concerned about the impact the mighty dollar might have on corporate earnings and worried about a potential U.S. Federal Reserve (Fed) rate hike.
- Emerging markets (EM), which saw patchy performance on a country-by-country basis amid ongoing concerns about slowing global growth, declining commodities prices, and the strength of the U.S. dollar, were slightly down for the period as a whole.
- Geopolitical worries remained a concern. Nuclear treaty talks with Iran, sanctions against Russia, possible military action against ISIS, troubled oil and commodity prices, and Greece’s recalcitrance and its effect on the sustainability of the European Union (EU) continue to distract investors.
- Amid this uncertain and shifting environment, equity valuations appear somewhat stretched in the U.S., attractive in Europe, and still below historical averages in emerging markets.
- Though we still see expansion in a number of economies, collectively, the global recovery remains uneven, and breadth of economic activity has moderated. Thus we are cautious about the sustainability of the global recovery, particularly given the disparity in the extent of recovery seen in the U.S. compared to other economies.
- Europe’s positive performance in response to commencement of the ECB’s QE program provides optimism that the region may turn a corner and begin to show some sustainable growth. Much like the U.S. stock bull run alongside the Fed’s QE program, easing in Europe should help European manufacturers and exporters, especially the larger continental economies such as Germany and France.
- The situation in the U.S. appears to shift monthly, as seemingly conflicting economic data releases push the markets in one direction or the other. In turn, investors are optimistic in response to solid employment numbers or pessimistic about the strong dollar’s effect on corporate earnings.
- Despite slipping back into recession late in 2014, Japan still appears to be benefiting from Prime Minister Abe’s economic reforms. The government’s stimulus programs and the resulting weakened currency are disproportionately aiding manufacturers and exporters, while deflationary pressures remain for the more domestically focused elements of the economy.
- The strength of the U.S. dollar, weakness in global growth, and the uncertainty around energy and commodity prices continue to buffet emerging markets, despite pockets of solid performance in the region and generally favorable earnings news.
The big question as the first quarter drew to a close was: How sustainable is the global recovery? In fact, we wonder if it should be considered in terms of a global recovery at all, or rather as a series of isolated regional recoveries.
The hesitation in the U.S. economic growth this quarter underscored how fragile recovery is in the other regions of the globe. While U.S. investors fretted about possible rising rates at home, non-U.S. investors dealt with the dual worries of the strong dollar’s effect on economies outside the U.S. as well as the possibility that the U.S. recovery—the engine driving global growth—might be losing steam.
Stabilization in oil prices helped soothe some nerves. And some long-awaited good news out of Europe suggested that other parts of the world might finally join the recovery party. However, the ongoing divergence of monetary policy and central bank activity between the U.S. and U.K. and the rest of the world makes it clear that there is no one answer to any question about global recovery. Aggressive easing continues in China, Japan, Europe, and the emerging markets in attempts to spur growth in those stubbornly sluggish economies while the Fed and Bank of England carefully monitor public statements about when and how they will begin to tighten monetary supply.
Outside the U.S., consumer confidence is growing in response to increased disposable income. As in the U.S., lower energy prices have put more money in consumers’ pockets in Europe. Simultaneously, QE has improved the job picture, made more money available for small businesses, and eased credit conditions for consumers. The resulting confidence among consumers is likely to drive growth in the consumer discretionary and consumer staples sectors as well as in select industrials positioned to benefit from increased consumer activity after the long lull.
All this confirms our view that a bottom-up, stock-by-stock analysis is the appropriate way to uncover opportunities for sustainable growth in such a complex, fragmented environment.
European stocks rebounded in the first quarter as the ECB began its long-anticipated bond-buying program, snapping up €60 billion worth of sovereign bonds on a monthly basis to pump stimulus into the economy. Hoping to take a page out of the Fed’s success story, the ECB has pledged to take any and all steps necessary to stimulate the region’s economy and reverse its deflationary spiral.
The cloud seemed to lift finally across the continent; consumer and business activity immediately picked up, and economic data seemed to follow suit. Employment, consumer confidence, and purchasing managers index data was up, and the zone’s gross domestic product (GDP) figures grew for the third consecutive quarter.
We look for the aggressive stimulus to initially benefit those smaller firms who traditionally have the greatest difficulty with a tight money supply. The weakening euro versus the U.S. dollar and other major currencies should also act as a tailwind by making European manufacturers and exporters more competitive globally.
The concern amid the optimism lies in the viability of the region and its one currency overall. Ongoing negotiations with Greece about austerity, bailouts, and loan repayment have not been productive, with moments of tense threats and saber-rattling thrown in for good measure.
The U.S. recovery faltered in the first quarter. Concerns about the effects of the strong dollar on corporate earnings growth and potentially higher interest rates on the U.S. economy and, by extension, global growth, kept stocks in check for the first three months of the year.
As discussed earlier, the U.S. market seems to be moving in response to the latest economic data release. Solid housing numbers send stocks toward new highs, then weaker-than-expected earnings releases spur fears of stagnating global growth and stock retreat. Soft durable goods data worry investors but the resulting dovish remarks from the Fed suggest it may hold off on a rate increase and stocks rally.
American consumers continue to enjoy their oil price dividends. Lower energy costs have spurred spending in consumer discretionary areas, including restaurants, travel, retail, and home improvement. Improvement in non-residential construction has helped as well, benefiting construction-related industries, such as equipment rentals, home and office fixtures, and real estate investment trusts (REITs).
The employment picture continues to improve. Nonfarm payroll employment grew by 295,000 in March, and the headline unemployment rate fell to 5.5%. Since this represents the outside edge of the Fed’s stated employment target before considering a rate increase, the news was both positive and negative for investors.
Accordingly, the potential cloud on the horizon remains the increasingly likely possibility that the Fed will raise interest rates sometime this summer. While such a move may be priced into the markets, there remains a chance that it could prove a shock to the system after the years of easy liquidity and slow or even stall the recovery.
After slipping into recession in the fourth quarter of 2014, Japan rebounded in the new year. As a net energy importer, Japan is a big beneficiary of lower oil prices. Industries exposed to oil prices, such as auto components, airlines, and transportation, all gained in the first quarter. And, of course, exporters continue to benefit from the yen’s weakness amid the government’s ongoing stimulus policies.
Economic data was mixed during the period, suggesting industrial strength but consumer weakness. Additionally, lower oil prices, while helping select sectors in the short term, pushed inflation lower, contrary to the central bank’s intentions.
These conditions underscore the uncertainty surrounding the long-term sustainability of the Japanese reforms, and we remain concerned about the economy going forward. Data support the trends: The yen continues to weaken, benefiting export- and industrial-based companies, but consumer activity and capital investment have been uneven and equities have stagnated, despite better earnings.
Emerging markets trailed all other regions again in the first quarter, still suffering amid unstable oil and commodity prices and a soaring U.S. dollar. Weakness in the global economy will naturally weigh on EM due to their inherent sensitivity to global activity and export demand. The extent to which each country is levered to global activity will have an important impact on relative returns throughout the year but this dispersion between individual markets should offer opportunities for active managers.
Therefore, given this weakness in global activity, it should not be surprising that the themes we are watching focus on the positive trends in domestic demand, either driven by reform or clear changes in consumer behavior.
The recent weakness and general underperformance relative to developed markets has left EM trading below historical averages, creating a potential opportunity. Examples of opportunities in today’s challenging environment come as a result of the effects of increased disposable income, notably uptrending global auto penetration and online search and e-commerce, both of which have benefited from increasing standard of living across the region in the longer term as well as the recent decline in energy prices in the shorter term.
EM investors are wise to keep an eye on the strong dollar. Divergence in central bank policies is likely to continue until sustainable, long-term improvement is achieved across the developed markets. The dollar’s effect on commodity prices and current account balances for EM economies could continue to hinder EM markets as a whole.
A sluggish China is reason for concern as well. Emerging markets’ reliance on the regional giant means that the longer it takes to shake the current slow-growth fog and resume sustainable growth, the longer EM economies could suffer.
We expect performance in EM to continue to be a case-by-case scenario. While individual countries are outperforming—India, for example is benefiting from increased confidence after election of a reform-minded government—exposure to energy and commodity pricing and ongoing geopolitical issues will trouble investors about the region as a whole.
Of course there are also reasons to be optimistic; improved fiscal responsibility, focus on reform, and increased infrastructure spending are creating individual pockets of opportunity within the region.
As dedicated bottom-up stock pickers, we are committed to keeping short-term market trends in perspective as we maintain our disciplined investment approach. Though optimistic amid recovery in the U.S., U.K., and Europe, many investors remain cautious about currencies, interest rates and overall global growth. We believe that by analyzing opportunities on a company-by-company basis, regardless of short-term market conditions, we will be able to uncover attractive stocks that can offer the earnings acceleration potential that is the cornerstone of our investment process.
The opinions expressed are those of American Century Investments (or the fund manager) and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.
For detailed descriptions of indices or investing terms referenced above, refer to our glossary.