Although not a Goldilocks scenario, our forecasted macro-backdrop is quite positive for global equities. Indeed, aggregating our national forecasts from our base date of September 24th, we forecast that the MSCI World Total Return Index will increase 2.8% (unannualized) through December in USD terms (+3.9% in Yen terms) and 5.6% by March-end (7.8% in Yen terms). These are very attractive gains in today’s low interest environment, especially for Yen-based investors.
The SPX is now trading at 16.6 times NTM (next twelve month) earnings, which seems a bit high in a historical context, but due to interest rates remaining structurally lower than any time since the 1950s, we believe this is a fair valuation. However, we do not believe further re-rating is possible now that bond yields are likely to rise, but we think stocks can rise along with earnings. We are slightly less optimistic than consensus about earnings, greatly due to the negative translation effect of USD strength on overseas earnings, but we expect earnings to grow 9% in 2015, while M&A and share buybacks should also support the market in the current low interest rate environment.
The Eurozone has plenty of internal hurdles and is likely to encounter occasional jitters, as it is highly exposed to China and Russia, as well. However, after a significant equity market correction, the market is trading at 13.2 times 2015 earnings estimates and no longer seems expensive or over-owned by global investors. Clearly, we are not optimistic, but neither are we as pessimistic as the market seems to be about the European economy. Thus, we believe that stocks can rising along with earnings, which should grow in the low teens annualized rate in the 1H15 and be supported by rising M&A activity, the ECB’s new QE policy and extremely low interest rates.
Although the market has risen in recent months, this is primarily due to the weak Yen, and in truth, Japan remains under-owned and under-appreciated. Abenomics has disappointed some investors and skepticism remains fairly high, but such is fading as more good news comes out, especially on corporate taxes and GPIF’s asset re-allocation. Indeed, we believe that Abenomics is working well, especially for corporations (with pretax profit margins soaring to historical highs for both manufacturing and non-manufacturing sectors. see p.9) and equity investors, and that it will continue to do so. Indeed, the market PER of 14.9 NTM earnings basis is very attractive and earnings estimates will likely continue to improve, partly due to the weak Yen but also due to the global economy and reduced skepticism by analysts. Regarding TPP, PM Abe has made it clear that he will do everything necessary for it to be successful and we estimate that it will pass the US Congress next spring, especially easily if the Republicans win the Senate. This is perhaps the most important part of the “third arrow” set of reforms, but a large number of other reforms have been enacted “behind the headlines” due to their political sensitivity. Lastly, we forecast that an equity culture is bound to develop in Japan, as remaining risk free will likely mean poverty in retirement, as both inflation and VAT rates are likely to rise over the short, intermediate and long term.
In sum, we forecast that the US will underperform in the next six months, with Europe regaining some of its lost performance and Japan and Asia Pac ex Japan performing the best.
Undoubtedly, geopolitics remains a significant risk factor and we will continue to be ready to react to any change in our view. Similarly, events relating to China’s economy (and/or Europe’s) must be watched very carefully because the tail risk of a major downturn is far from negligible. Lastly, the chance that the global bond markets might sell off more than we expect due to fears about central bank policies is not an impossible risk either.
Investment Strategy Concluding View
We calculate that equity valuations are at fair levels (with some slight undervaluation in Europe and Japan) and that stocks can grow along with earnings due to: 1) a relatively sturdy G-3 macroeconomic backdrop. 2) some softening of geopolitical risks and 3) other supporting factors such as Abenomics in Japan, some relief about Europe and increased global M&A activity. These events, in turn, will, coupled with a tighter Fed, likely cause bond yields to rise moderately, so we increase our overweight view on global equities vs. bonds, while shifting to a more aggressive stance on regional equity weightings.