Reversal from our cautious outlook in September
In our meeting on 26 September 2019, we were, as in June, quite evenly divided between a rather benign global scenario and a moderately-cautious scenario, but we ended up again choosing the latter. As stated at the time, we had a clear bias towards a slightly better outcome than our chosen scenario and improvements have indeed occurred since the meeting. So we now shift to that more benign scenario, including the utilisation of all its targets, and away from our post-June, very rare stance of being mildly negative (not bearish, but cautious) on global equities, in aggregate, for intermediate to long-term global investors. We continue to believe that political developments are just as important as economic ones, and though the former are still difficult to predict, there has been some improvement in the China-US tariff war, Brexit, and at least for the time-being, Middle East geopolitical issues. We now expect the US to cut at least a portion of its 1 September tariffs, with no additional tariffs on consumer goods, but for the first few tranches of US tariffs to remain at 25%. As for the US election, it is too soon to make a strong prediction, but the odds for a Trump election are likely lower than accepted by the market.
Global growth should remain mild, near consensus
In our new outlook, the G3 and Chinese economies should grow around consensus (instead of mildly below consensus as per our September decision) through September 2020, with their central banks remaining basically on hold. US GDP, at a 1.6% Half on Half Seasonally Adjusted Annualized Rate (HoH SAAR, as used in all references below) in the 4Q19–1Q20 period and 1.9% in the 2Q20–3Q20 period, should hit economist-consensus expectations, with personal consumption and government spending likely being the major contributors to growth, while inventories should be quite volatile and unpredictable, especially due to Boeing’s aircraft production problems. Meanwhile, the Eurozone’s GDP should grow 0.8% and 1.1%, respectively, and Japan’s will likely be -0.8% and 0.9%. Japan’s forecasted weakness in this quarter is due to the VAT hike in October, although we expect the front-loading of spending before such and subsequent dip to be more moderate this time compared to the 2014 hike when Japan’s economic stability and consumer/corporate confidence was much less sturdy. Recently initiated government fiscal stimulus will also help buffer growth. For CY19, growth for the US, Eurozone and Japan should be 2.3%, 1.1% and 0.9%, respectively, with CY20 at 1.8%, 1.0% and 0.3%. Lastly, China’s official GDP should be 5.5% and 5.9% HoH SAAR, respectively, with CY19/CY20 GDP at 6.1%/5.7%. Overall, these G4 GDP results should satisfy risk markets, while corporate profit estimates for CY20 should stabilise at, or even moderately improve upon, the current consensus for moderate growth.
There is absolutely good reason for continued concern about many geopolitical issues, especially regarding China, the Middle East and Brexit. The trade war with China will likely see some truce fairly soon, with continued talks ahead, but such will not, in our view, prevent tariffs on all goods from being eliminated. Major yuan devaluation, however, is unlikely. We continue our stance that regarding the auto trade dispute between the US and Europe/Japan, Trump will likely feel that he cannot battle them while confronting China, and will take heart that their FDI in the US auto industry is increasing substantially, even for hybrid/electric models. However, we expect the ‘technology war’ will continue to be a global economic inhibiter in the name of national security. There is also the possibility that North Korea could become a hot issue again and the Hong Kong problem is far from being solved. In Europe, there never seems to be an end to the messy politics in the region, and Brexit will likely continue to worry markets at times (although we continue to forecast no ‘hard Brexit’ in the near term). The crisis between the US and Iran is quite scary indeed, although Trump seems unwilling to take the first military shot. Meanwhile, the Yemen/Iran alliance’s attack on Saudi facilities was a huge event, but the Saudis have acted calmly so far. Lastly, within the US, while market uncertainty related to impeachment and recriminations by both parties may rise sharply at times, the chance of a major US political upheaval remain slim in the next two quarters. Worries about the presidential and congressional 2020 elections, however, will increase for the markets.
Central banks: not a lot more to be done, barring crisis
Our G3 forecasts were on target so far (although we did not specifically make a prediction on ECB QE), but we no longer expect 4Q19 BOJ and ECB cuts of 10 bps, nor another 25 bps Fed cut in the 1Q20. We expect the PBOC to be basically on hold too. As for inflation, we expect US Core CPI to be 2.3% YoY next March and September, with higher import tariffs adding to inflation while decelerating housing rent and new statistical methods should be headwinds for inflation. We expect the headline CPI also to be 2.3% in those periods, with oil prices rising mildly. Indeed, globally, relatively stable inflation numbers, and the outlook for such continuing to be so, will help keep central banks on hold. As for overall commodity prices, the Bloomberg Index should also move upward in the next few quarters, primarily led by a recovery in oil, although gold should remain moderately below $1,500.
Flat USD and rising G3 bond yields
In shifting to that more benign scenario, we now expect G3 bond yields to consolidate their recent rise. For US 10-year Treasuries, our target for end-March is 1.90%, while those for German Bunds and 10-year JGBs are -0.40% and -0.10%, respectively. For next September, we expect 2.00%, -0.30% and 0.00%, respectively. Regarding forex, we expect the yen and euro at 108 per dollar and $1.10, respectively, through next September.
This all implies (coupled with our forex targets) that including coupon income, the FTSE WGBI (index of global bonds) should produce a 0.1% unannualised return from our new base date of 6 November through March in USD terms and -0.4% through next September. Thus, we have an unenthusiastic stance on global bonds for USD-based investors. For yen-based investors, the index in yen terms should return -0.8%, and -1.3% for those periods, with JGBs returning +0.2% and -1.0%.
Decently high global equities returns
A good amount of improvement in geopolitical affairs, especially the US-China dispute, is already priced into markets, and there remain many US election and geopolitical problems to sort out, coupled with unpleasant US-China relations no matter who wins the US election, so our new scenario is not aggressively bullish on global equities. Aggregating our national forecasts from our base date, we forecast that the MSCI World Total Return Index in USD terms (instead of our prior estimate of only small gains through March and September) will be 3.0% through March and 8.8% through September ( +2.0% and +7.8% in yen terms, respectively). Given all the risks present and the likely high volatility, this suggests a moderately positive stance for both USD-termed and yen-based investors.
In the US, the SPX’s PER on the CY19 EPS consensus estimate is now 18.9 times, which is on the expensive side even given the prevailing low interest rates, but dividend yields are relatively attractive and there is now greater confidence for better CY20 EPS growth due to the improved global outlook. A continued high level of share buybacks will also help support the market, so we expect the SPX to rise to 3,141 (+2.8% total unannualised return from our base date) at end-March, and to 3,289 next September (8.6% return), with yen based returns being +1.9% and 7.6% respectively.
European equities will clearly benefit as the US-China trade conflict steadies and although GDP should be very near recession in the 2H19, the outlook for 2020 is better. So, especially as Brexit-related political risks decrease, we can be more positive on the region’s equities. The PER has risen back towards the higher end of historical norms, at 15.7, but here too, the dividend yield and other equity factors compare favorably with the region’s absurdly low interest rates. In sum, we expect the Euro Stoxx index should rise to 407 at end March, and FTSE to 7,800, which translates to returns of 3.9% (unannualised) for the MSCI Europe through March in USD terms (3.0% in yen terms). Returns through next September will be even be better, at +10.8% (and 9.7% in Yen terms) in our view.
Japanese equities should rebound on the improved global outlook and on the rotation towards laggards and value-plays. Valuations remain very low, with TOPIX at 14.1 times a CY19 EPS consensus earnings. Improvements in the global semiconductor and smartphone cycles (which previously hit Japanese semiconductor product equipment, electronic components and supplies very badly) and better Chinese demand for capex goods should boost EPS estimates next year, and thus incentivize investors, especially foreigners, to return to Japanese equities. The TOPIX dividend yield of 2.3% is very attractive for domestic and foreign investors, and corporate governance continues to improve (despite a few hiccups) with share buybacks rising very sharply. Thus, we expect TOPIX to remain sturdy at 1690 by March and rise to 1757 by September, for total unannualised returns of +1.6% through March in USD terms (0.7% in yen terms) and 6.8% (5.8% in yen terms), respectively, from our 6 November base date. There is some market uncertainty about how economic sentiment will fare after the VAT hike in October 2019, as the last hike caused major disruption, but we expect the bumps should be quite mild this time. Furthermore, we expect the Olympics to provide a boost to the economy, and after the events, significant fiscal stimulus to prevent any major economic slowdown.
Developed Pacific-ex Japan MSCI: Any improvement in China-US relations should clearly help this region, but Hong Kong’s political unrest is certainly a key headwind. After its recent decline, we are not overly negative on the Hong Kong market and meanwhile we are quite positive on Australia due to its strong gearing toward global growth and a highly accommodative central bank despite a resurgence in its property market. In sum, we expect the region’s MSCI index in USD terms to rise 4.6% through March and 7.9% through next September (+3.6% and +6.9% in yen terms).
Investment Strategy Concluding View
The Global Investment Committee was fairly correct in being cautious on global risk markets from end-June through October, but events have changed for the better since then, so we have upgraded our outlook. We expect good USD-termed gains in all major global equity markets through March and next September. Thus, medium to long-term global investors should certainly consider overweighting global equities vs. global bonds and domestically focused investors should consider overweighting their country’s equities vs. its bonds as well.