I would argue that QE and negative deposit rates are largely in the price of European equities, but the growth story is not. This is why some remain overweight the region.
Japan is about so much more than QE as well. The numbers involved are already staggeringly large relative to gross domestic product, but there is every reason to feel confident that if growth stalls or inflation undershoots they will increase the quantum or broaden out asset purchases. The government and central bank are fully committed to this course of action and have the mandate to follow through – for another three years at least in Japan’s prime minister Shinzo Abe’s case.
But the underlying story in Japanese equities is also very encouraging. It has the best earnings momentum of the major developed markets, and improved corporate governance looks set to boost returns on equity and margins. Meanwhile, the market is highly geared into a better growth environment in the West, which we expect to be led by the US. Moreover, this growth potential is not reflected in valuations which are on a par with peers but lower than their own history.
The obvious thing to note with emerging markets, especially now, is that they should not really be looked at as a homogeneous group. India has always had very different dynamics than Brazil, for example. But in today’s environment those differences look even more stark. Brazil became increasingly reliant on China’s seemingly unquenchable thirst for commodities and put nothing aside for a rainy day. Consider what happens when you combine that shock to growth with a tumbling oil price, a huge corporate and political scandal, runaway inflation caused by a freefalling currency, and twin deficits. India on the other hand benefits from lower oil prices and has seen resurgent confidence following the emphatic election victory of the pro-business, pro-reform Mahendra Modi as prime minister.
Meanwhile, falling inflation has allowed the central bank to cut interest rates and help boost growth. This does not mean managers are overweight India and underweight Brazil but some have recently allocated more money to relatively unconstrained emerging market managers who can pick up quality companies that are priced too bearishly.
Some managers continue to have a fairly neutral weighting in US equities, despite being more positive on the economy than consensus forecasts. Our expectation is that the economic data will pick up markedly as we move through Q2 after another surprisingly soft Q1. Whether it is mainly a function of repeated bad weather in recent years or not, there is a clear pattern emerging in US quarterly GDP numbers where the first three months of the year have serially been weak and growth subsequently bounces back strongly later in the year. Nonetheless, valuations are undoubtedly high relative to history and to other developed markets. Earnings expectations also seem unrealistic, even in a stronger growth environment.
