Global Growth Should Rebound Moderately

It certainly has been a scary ride for the past three months, but for long-term global investors, it has been correct to continue having an overweight stance on a globally diversified portfolio of equities. Timing the markets is never easy, especially for large institutional investors, and the MSCI World Index actually rose an annualized 13% in USD terms since our last meeting, justifying our “tempered positive” view. Clearly, global GDP continues to be in a soft patch, primarily caused by the fears and direct effects of the US-China trade/technology war. The question is how long will the war and soft patch last? The markets have strongly indicated that they do not think such will persist and are looking forward to major improvements in overall conditions ahead, especially due to the Fed pivot. In the background, there is a generalized concern about being at the end of an economic cycle, coupled with high debt levels that are becoming hard to sustain, but we all know that this cycle is very different than all previous ones, so it is very difficult to predict and at we know, at least that central banks are certainly giving the world another helping hand. The basic maxim of not fighting the central bank seems to be holding up now after a period when the Fed seemed to be wanting to take away the punch bowl.

Thus, we continue the view of the last meeting that economies will slow but not falter in 2019. Some on our Global Investment Committee think that the balance of potential risks is to the downside, while others believe there are mostly upside risks, but the majority expect a moderately good path ahead. We also continue our stance that BREXIT, the China-US trade wars and all the major outstanding geopolitical risks will not be major problems. While some may have thought such foolhardy, it has proven to be correct. So, the G-3 and Chinese economies should grow decently through March 2020, approximately in line with the expectations of major economists, while we expect central banks to very gradually reduce their accommodation late in the twelve-month horizon, similar, but not exactly the same, as consensus expectations. With such as the backdrop, we expect bond yields to rise mildly, the USD to be roughly flat and equity markets to rise further. Clearly, there are significant downside risks, but obviously upside risks as well.

Through March 1st, MSCI World in USD terms rose 3.2% from our November 30th base date vs. our +4.2% expectation (although our targets were for end-March, so much depends on the coming weeks’ developments). The S&P 500 and TOPIX undershot our targets while EuroSTOXX was on target and the Hang Seng and ASX indices surged above our quite positive targets. Globally, bonds performed better than we expected, while our currency calls were mixed, with the EUR on target but the JPY moderately stronger than we expected.

In our early December meeting, our G-4 GDP forecasts for the 1H19 were clearly too high, but our 2H forecasts currently match consensus. Looking forward, U.S. GDP, at a 2.3% Half on Half Seasonally Adjusted Annualized Rate (HoH SAAR) in 2Q19-3Q19 and 2.1% in 4Q19-1Q20, should match economist-consensus expectations. Growth should come from increased personal consumption and fixed asset investment, while net trade will likely be a very volatile factor. Meanwhile, the Eurozone’s and Japan’s GDPs will likely both grow at 1.7% on a HoH SAAR basis in 2Q19-3Q19, and 1.8% and -0.5%, respectively, in 4Q19-1Q20, both also approximating consensus expectations. Japan’s forecasted weakness in the latter period is due to the VAT hike scheduled in October, although we expect the front-loading of spending before such and subsequent dip to be quite moderate this time, especially compared to the 2014 hike when Japan’s economic stability and consumer/corporate confidence was much less sturdy. For CY19 data, growth for the U.S., Eurozone and Japan should be 2.5%, 1.3% and 0.7%, respectively. Lastly, China’s official GDP should be approximately 6.3% HoH SAAR in both periods. Here too, personal consumption will likely lead the way, while fiscal stimulus will begin providing more support, as well. Overall, these results should re-assure risk markets, and corporate profit estimates should continue to show decent growth globally in 2019, with a large potential for EPS estimate increases globally once the China-US trade deal is done.

As for geopolitical issues, we still believe that such will be handled without crisis due to the strong economic incentives of all major players, but there are many situations that bear close monitoring, especially regarding China, the Middle East and BREXIT. The trade dispute between the U.S. and Europe looks ominous, especially when connected to the likely Section 232 action on autos, but some exemptions or qualifying measures will likely be given. This action will also likely impact Chinese auto part exports to the U.S., which are quite substantial, to a large degree, while Japan and Korea will likely receive major exemptions. The trade war with China will likely see some truce fairly soon, but such is definitely not 100% certain and there remain many other areas, particularly the “technology war,” that will continue to be global economic inhibiters in the name of national security. There is also the possibility that North Korea could become a hot issue again. In Europe, there never seems to be an end to the messy politics in the region, and BREXIT, while not likely an imminent problem, remains troublesome. Lastly the U.S., while market uncertainty related to impeachment and recriminations by both sides may rise at times, the chance of a major political upheaval remain slim.

Central Banks: Normalization Moderately Delayed

Clearly, our Fed call for 25 bps hikes in 4Q18, 1Q19 and 2Q and then pausing, was too hawkish, even though it was a bit on the dovish side at the time, as quite a few major investment banks were calling for three or four hikes in 2019. We now expect 4Q19 and 1Q20 hikes and tapering of the balance sheet runoff in 4Q19. As we expected, the ECB ended QE in December and we shift our call for its first 20 bps hike from late 2019 to 1Q20. Meanwhile, we were accurate that moderate-sized TLTROs would be issued in the 1H. We still do not expect any BOJ hikes in policy or YCC rates for the next four quarters due to the VAT hike in October 2019, but there is a major chance that ETF purchases will be tapered in the 4Q19 if equities rally as much as we expect. As for inflation, we expect U.S. Core CPI to be 2.2% YoY through March 2020; and as we expect the Brent oil price to rise moderately through then, we expect the headline CPI to be 1.7% in June 2019, and 2.2% in March 2020, which are basically perfectly on target for the Fed. Overall commodity prices should also move mildly upward in 2019, primarily led by a recovery in oil due to OPEC regaining better control of the market. Although global growth should keep global commodity demand quite firm, investment speculation in commodities should diminish.

Flattish USD and Mildly Rising G-3 Bond Yields

Given our scenario, we expect G-3 bond yields to continue rising slightly in the next few quarters. For U.S. 10Y Treasuries, our target for end-June is 2.8%, while those for 10Y JGBs and German Bunds are 0.0% and 0.15%, respectively. For calendar year-end, we expect 3.00%, 0.2% and 0.35%, respectively, and for March 2020, we expect 3.10%, 0.3% and 0.45%, respectively. This implies (coupled with our forex targets) that including coupon income, the Citigroup WGBI (index of global bonds) should produce a 1.5% unannualized return from our base date of March 1st through June in USD terms and 0.8% through December but -0.1% through March. Thus, we maintain a somewhat unenthusiastic stance on global bonds for USD-based investors. For Yen-based investors, the WGBI index in Yen terms should be the same because our Yen forecast is basically steady, and as for JGBs, we target the 10Y to have moderately negative Yen-based returns in the year ahead.

Regarding forex, although Fed policy will tighten a bit faster than the BOJ and ECB, global worries about U.S. budget and trade deficits, coupled with an uncertain U.S. political situation, should restrain USD enthusiasm, so we expect the Yen and Euro to be basically flat in the four quarters ahead from our base date levels of 112 and 1.14 respectively. Meanwhile, our call for the AUD:USD is for 0.72 at end-September and 0.73 at end-March 2020.

Moderately Positive on Global Equities

Although improvement in geopolitical affairs, especially the U.S.-China dispute, and the related rebound out of the current economic soft patch is mostly priced into markets, our new scenario remains positive on global equities (as has been our view for virtually the entire period since the Global Financial Crisis), as decent economic growth should bring allow for corporate earnings growth estimates to be upgraded this year, while mildly rising interest rates should not curtail valuations much. Continued dovish stances by central banks should help all equity markets to some degree, although it is priced into markets by now. However, the impact of the upcoming international accounting changes to put leases on the balance sheet will likely cause headwinds for particular industries and decrease risk appetite in general as aggregate debt to equity ratios are significantly larger than currently reported levels. Aggregating our national forecasts from our base date of March 1st, we forecast that the MSCI World Total Return Index will increase 4.1% (unannualized) in USD terms through June, 10.3% through December and 12.0% through March 2020. Clearly, this suggests a reasonably positive stance on global equities for USD-based investors (and Yen-based investors, as well).

In the U.S., decent global economic growth, coupled with accelerating corporate operational efficiency, should more than offset the headwinds from new lease accounting rule, mildly higher interest rates and political uncertainty, so the equity backdrop is positive. The PER based on 12-month forward EPS is 16.1 times, which is fair given all these conditions, and as mentioned earlier, we expect earnings estimates to be upgraded. A continued high level of share buybacks also will help support the market. Given all of this, we expect the SPX to hit 2893 (3.8% total unannualized return from our base date of March 1st) at end-June, and 3007 at the end of 2019 (8.9% return).

European equities have been performed well in EUR and USD terms during the last three months and hit our relatively optimistic index target for end-March. Most European macro-economic data are still showing signs of deceleration, but much of this is related to the China slowdown that the markets are now predicting will end. GDP should be reasonably solid from the 2Q19, especially by mature-country standards. Political risk, including new domestic regulatory and tax threats, will occasionally haunt the markets at times, but we see no major crisis ahead. Thus, continued low interest rates and decent earnings increases from global economic growth should help its equity market to rebound further. Notably, rising oil and commodity prices, to which UK and European corporations are highly geared via multinational companies, should also boost corporate earnings. Furthermore, the European PER on next-12-months EPS is low at 13.6 and will likely rise somewhat, so we see the Euro Stoxx index rising to 375 and the FTSE to 7300 at end-June, and to 392 and 7550 at year-end, which translates to 4.5% and 12.0% unannualized MSCI Europe returns in USD terms for those periods. A high dividend yield of 3.8% also is very supportive of European equities.

Japanese equities have disappointed, falling significantly in USD terms during the reporting period, but now valuations are very low, at 12.4 times next 12-month EPS. It must be said that the decline in the global semiconductor and smartphone cycles (which hits Japanese semiconductor product equipment, electronic components and supplies very badly), soft global auto sales, weakening Chinese demand for capex goods and other factors have pushed down EPS estimates this year and next, but most analysts expect the semiconductor cycle to improve in the 2HCY19. Also, there are signs that China’s demand for Japanese capex goods has bottomed out, which is a very helpful sign. YoY EPS growth for CY19 is deemed about flat, but as discussed earlier, we expect earnings estimates to increase once the U.S.-China spat is at least partially solved, while the dividend yield of 2.4% is particularly attractive for domestic investors. Companies still have high operational gearing to continued global economic growth, so our expectation for improved sentiment for the latter should lead to greater interest in Japanese equities. Meanwhile, corporate governance continues to improve (despite a few hiccups), with share buybacks rising very sharply, so we expect TOPIX at end-June to be 1679, with 1792 through December for total returns of 4.7% and 12.9% in USD terms, respectively (and virtually the same in Yen terms too). As mentioned earlier, there is some uncertainty about how volatile economic sentiment will be in the lead up to the proposed VAT hike in October 2019, as the last hike caused major disruption, but we think the bumps should be quite mild this time as the economy is now on much sturdier ground and consumers realized that they over-reacted the last time.

As for the Developed Pacific-ex Japan MSCI, it moved from disappointing performance during the majority of the year to quite exuberant in the last three months due to lessened trade fears. A more dovish Fed also helps Hong Kong shares, which are greatly tied to the interest rate-sensitive domestic property market. Australia’s economy is currently as weak as it has been in ages, but iron ore prices have held up due to the Brazilian disaster, as has inward tourism. The downturn in the property markets of each country is quite nerve-wracking, especially given the secondary effects, but we expect the region’s MSCI index to perform well ahead, leading to a 5.5% unannualized return in USD terms through June and 14.0% through year-end.

Investment Strategy Concluding View

There is no doubt that geopolitical tail risks remain significant, but the Global Investment Committee retains its moderately positive outlook because the net impulses for global economic growth and corporate profits should improve. Thus, similar to our meetings of the last decade, this justifies a positive stance on global equities. Meanwhile, global bond yields should rise slightly, so we maintain a mildly unenthusiastic stance on global bond returns.