Global Equity Outlook
Third Quarter 2015
- Divergence of monetary policy among the world’s central banks remained one of the top headlines in the second quarter of 2015. Joining it, and closely related, was ongoing speculation about the potential for an interest rate hike from the U.S. Federal Reserve (Fed).
- While the potential for rate hikes in the U.S. and U.K. appears increasingly likely, the European Central Bank's (ECB) quantitative easing (QE) program, began late in the first quarter, helped support eurozone companies and consumers. QE continued apace in Japan and China, and other central banks, such as in South Korea and New Zealand, announced additional monetary easing during the quarter. In this environment, stocks were mixed in global markets, with Europe and Japan the clear winners.
- Japan led all other markets in performance, buoyed by ongoing stimulative policies and the resulting weaker yen. Japanese stocks also benefited from new government mandates favoring pension fund investment in equities and better corporate governance.
- ECB QE benefited stocks across the region. European manufacturers and exporters saw a weaker euro make their goods more attractive to foreign buyers. In general, stocks also benefited from boosted investor confidence.
- U.S. stocks, up slightly for the period as a whole, moved according to the whims of investor sentiment regarding the Fed’s intentions. At one point, weak gross domestic product (GDP) growth data led to speculation a rate increase might be delayed, which temporarily weakened the U.S. dollar and buoyed stocks. Contrastingly, any positive economic news, such as better-than-expected employment data, bolstered the hawkish case that a hike might come sooner rather than later. Stocks dipped on such news but the dollar rallied versus the euro and other major currencies.
- Emerging markets (EM) continued to experience mixed results on a country-by-country basis. Concerns around sluggish growth in the U.S. and China, weak commodities prices, the strong U.S. dollar, and a looming Fed tightening cycle weighed on EM stocks as a whole, though there were pockets of solid performance in Asia.
- Geopolitical worries remained a concern. Saber-rattling by all sides in the negotiations around Greece’s debt repayment worried investors somewhat as to the long-term sustainability of the European Union (EU).
- Divergence in monetary policy, between the U.S. and U.K. on one side and the central banks of Europe, Japan, China, and others on the other side, remains the top story. Questions surrounding when and how much the Fed and Bank of England (BoE) might act to tighten money supply and the extent such moves will have on two of the world’s top economies, will continue to drive investor decisions, in our view.
- Though global recovery remains slow yet steady, the breadth of economic activity has been reduced. For that reason, we maintain our cautious optimism concerning global recovery and its sustainability.
- Europe appears to have turned a corner toward sustainable recovery after posting its fourth consecutive quarter of expansion. The ECB’s QE program should continue to support growth, bolster stocks, and boost investor confidence as the increased money supply improves access to credit and dampens the euro, making eurozone goods more attractive outside the region.
- In the U.S., investor sentiment will likely continue to shift with each new economic data release until the picture becomes clearer regarding the Fed’s intentions on interest rates. The current period of slow, hesitant growth appears likely to continue throughout the second half as well.
- Stimulative policies and Prime Minister Abe’s economic reforms may well keep Japan’s growth on track. QE has weakened the yen, and manufacturers and exporters, including automakers, machinery firms, and technology companies, are benefiting. However, deflationary pressures continue to affect the more consumer- and domestic-focused sectors of the economy. We will continue to monitor the country and wonder how long the government’s programs can keep the recovery afloat.
- We expect the strong dollar, sluggish growth in the U.S. and China, and uncertainty around the Fed’s actions to continue to buffet emerging markets, despite pockets of solid performance in the region and generally favorable earnings news.
As mentioned, speculation about whether, when, and how much the Fed might move hangs over the U.S. markets and, by extension, international markets as well. It is reasonable for investors to be concerned that the Fed, if too aggressive, could choke off the growth in the economic engine that has been driving global recovery for the past six years or so.
On the other hand, interest rate hawks worry that less-than-robust economic news will persuade the Fed to continue in emergency response mode long after the emergency has passed. This could allow disinflationary trends to continue while artificially keeping rates at unhealthily low levels.
The slowing of U.S. economic growth throughout the first half has shown how fragile global recovery is at its core. 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 or even be choked off should the U.S. central bank act too soon, too strongly, or too often.
Normalization in oil and commodity prices helped calm global investors somewhat after their downward spiral. Europe’s continued improvement suggests that other parts of the world might be able to keep the recovery on track if the U.S. falters. 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 are likely to be more questions than answers about the overall situation until the plans of the Fed and BoE become more readily apparent. In the meantime, stimulative policies continue in China, Japan, Europe, and select emerging markets in attempts to spur growth.
European stocks continued to benefit from the ECB’s long-awaited bond-buying program. Purchasing €60 billion worth of sovereign bonds on a monthly basis is pumping money into the economy and suppressing the level of the euro. By basically adopting the strategy the Fed used to get the U.S. economy back on track, the ECB has aggressively committed to pledges to stimulate the region’s economy and stocks.
Economic data suggests that the program has been a success so far. European stocks have been among the world’s top performers for the second quarter and the first half of 2015. Employment, consumer confidence, and purchasing managers index (PMI--an indicator of the economic health of the manufacturing sector) data is improving, and GDP continues to increase.
The ECB’s accommodative policies are keeping interest rates and the euro fairly low, and while growth continues, it continues at a modest pace in response. We expect that trend to continue, and for slow, steady growth to continue to keep deflationary trends at bay.
We look for European QE to first and foremost benefit small-cap stocks by improving their traditionally limited access to capital. The weakening euro versus the U.S. dollar and other major currencies continue as a tailwind, keeping European manufacturers and exporters globally competitive.
The concern amid the optimism lies in the viability of the region and its one currency overall. Negotiations with Greece about austerity, bailouts, and loan repayment linger on, and investors are keeping an eye on the situation lest failed talks threaten the cohesiveness of the European Union.
U.S. growth, while meager, continued in the second quarter. Corporate earnings reports were lackluster amid mixed economic data and the headwind presented by the very strong dollar. The prospect of higher interest rates and their effect on the U.S. economy and global growth left stocks up modestly for the quarter and the first half of the year.
As we have seen for most of the last two quarters, the U.S. stock market seems to react to each new bit of financial news. Solid job numbers send stocks down as investors worry the Fed may be spurred to act, then weaker-than-expected GDP data stoke fears of stagnating global growth and (counterintuitively) stocks recover because the Fed might hold off until next year.
Amid all that confusion, American consumers continue to enjoy the benefits of the hard-won recovery. While oil prices have stabilized somewhat, consumers are still enjoying lower prices as they take to the roads for the summer vacation season. Lower energy costs are supporting consumer discretionary areas, such as restaurants, travel, retail, and home improvement as well.
Employment data continues to be, while not robust, continually improving. Nonfarm payroll employment grew by 285,000 in June, slightly better than consensus expectations, and headline unemployment remained at a respectable 5.5%. This represents the outside edge of the Fed’s stated employment target before considering a rate increase, and, not surprisingly, the news was both positive and negative for the markets.
So, we await the resolution of the question about the likelihood that the Fed will raise interest rates sometime this year. 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.
Japan continues to ride the monetary stimulus train, and Japanese stocks have seen a significant run-up since the lows of late last year. A big beneficiary of lower oil prices, industries such as auto components, airlines, and transportation all continued to reap the benefits of depressed energy prices into the second quarter. As expected, manufacturers and exporters continue to benefit from currency weakness brought on by the government’s ongoing easing programs.
Economic data remained mixed throughout the first half, demonstrating industrial strength but consumer weakness. Additionally, lower oil prices, while stabilized somewhat in the second quarter, still aided select sectors in the short term but pushed inflation lower, contrary to the central bank’s intentions.
These conditions underscore our concerns as to the 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.
Emerging markets trailed all other regions in the second quarter, suffering amid the strong U.S. dollar, sluggish global growth, and the potential for a coming Fed tightening cycle. 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 we continue to watch those themes that 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.
China’s struggles continue to concern investors as well. The regional giant determines much of the EM’s growth prospects. Therefore, the longer its malaise persists, the longer EM economies could stagnate.
We expect performance in EM to continue to be a case-by-case scenario. While individual countries are outperforming, exposure to the dollar, uncertainty around monetary supply in the U.S. and U.K, 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.