Candice Bangsund, CFA, is vice-president and portfolio manager, global asset allocation, at Fiera Capital Corp.
Although equity investors were sides-wiped at the end of 2018 in what was an erratic trading environment, the good news is that global equity markets have regained some momentum so far this year, which has lent support to our view that the profound pullback witnessed in late 2018 was largely overdone.
Late last year, global equity markets posted their worst quarterly results since 2011 as investors worried about global trade tensions, rising borrowing costs and worrisome signs of slowing global growth.
Already, we are seeing some encouraging developments that could see both price-to-earnings multiples and earnings expectations revert higher over the course of the year.
Namely, the worst of the trade tensions may be behind us: The United States-Mexico-Canada Agreement has been signed, auto tariffs have been sidelined and the United States has held off on imposing additional tariffs (for now). What’s more, China has made some important concessions to the United States (specifically, pledging to reduce the trade deficit by purchasing more U.S. agricultural products) – all of which has indicated some willingness to compromise on trade.
Also, there are some tentative signs that continuing accommodation from major central banks and even some increasing of monetary and fiscal support from China could help to stabilize global growth.
Finally, while market sentiment remains fragile, the preconditions for a recession remain elusive. Looking ahead, global equity markets should remain well supported by the vigorous economic backdrop, healthy corporate earnings prospects and reasonable valuations – while the pragmatic approach to central bank normalization should allow the economic upswing to continue on uninterrupted, helping to counter any geopolitical uncertainties at hand.
Regional strategy: Leadership rotation under way
After an extended period of U.S. outperformance, we expect equity market leadership to rotate toward non-U.S. stock markets in 2019. Over the past few years, a predominant theme in equity markets has been the glaring outperformance of growth strategies compared with their value counterparts, which was most visible in the performance disparity between the United States and its global peers. Specifically, unnerved and growth-starved investors propelled toward the high-octane sectors of the marketplace (such as technology), which resulted in a sizable valuation gap between the S&P 500 Index and the MSCI All Country World Index – its largest since the depths of the financial crisis. However, we expect this growth-domination to unwind as investors embrace increasingly self-sustaining global economic growth and the corresponding rise in interest rates – an environment in which value-oriented investments typically thrive.
Taken together, we expect a rotation toward the underowned and underappreciated value-oriented space, with important implications for both Canadian and emerging-market stocks, which have been punished despite their sound fundamentals – leaving them ripe for a reversal should lingering trade headwinds recede and fundamentals begin to matter again.
U.S. equities: Priced for perfection
While U.S. equities should indeed thrive on a backdrop of buoyant domestic growth and earnings, much of the good news is already priced in. As a result, we expect that upside for the S&P 500 is limited compared with its global peers, and caution is warranted given relatively expensive valuations at a time when the U.S. Federal Reserve is leading the charge on interest-rate normalization and where the bar for positive earnings surprises remains high. Furthermore, a moderation in earnings expectations appears inevitable as the boost from fiscal stimulus fades in the back half of 2019, while the potential for political gridlock in Washington could also be a source of volatility for U.S. stocks in the coming year.
Canadian equities: Value back in favour in 2019
In these later stages of the business cycle, the global growth landscape has become increasingly entrenched. As a result, investors will no longer need to search for “growth at any price” and instead, we expect a rotation toward the underappreciated sectors of the market – which is inherently positive for the value-oriented S&P/TSX Composite Index. Specifically, in the energy space, shares of producers should be bolstered by the rebound this year in both Western Canadian Select and West Texas Intermediate crude prices, while our expectation for steeper yield curves should benefit the financial sector. Furthermore, sentiment toward Canadian stocks has been plagued by numerous headline risks at hand (most notably on the trade front), even as earnings expectations remained stable. As such, steep valuation discounts in the context of a sound fundamental backdrop argues for a reversal in the fortunes for the TSX, particularly as lingering headwinds fade.
Emerging-market equities: Compelling risk-reward proposition
Emerging-market equities have assumed the brunt of the weakness related to the U.S.-China trade dispute and a strengthening U.S. dollar. While pockets of vulnerability indeed exist across select economies (Turkey and Argentina, for example), we expect weakness to be contained and unlikely to spread more broadly across the emerging-market space. Importantly, many emerging-market countries have improved their financial positions since the 1997 crisis, the 2008 global financial crisis and the 2013 taper tantrum and as such, are better able to tolerate higher U.S. borrowing costs. We believe that investor positioning in emerging-market stocks remains too pessimistic in the context of superior growth prospects compared with the developed world, reasonably bright earnings momentum and attractive valuations – while a less-aggressive Federal Reserve and softer U.S. dollar conditions should also alleviate some of the pressure on emerging market assets in general.