2015 Q2 House Views Update
by Nikko Asset Management's Global Investment Committee
- G-3 Economies Should Continue Rebounding
- Central Banks: Our Logic For Fed Hiking Three Times This Year
- Forecasts for Stronger USD and Moderately Rising Global Yields
Our forecasted macro-backdrop is mostly positive for global equities, but it is likely to be very volatile ride. Indeed, aggregating our national forecasts from our base date of June 19th, we forecast that the MSCI World Total Return Index will increase 1.3% (unannualized) through September in USD terms (+3.1% in Yen terms) and 6.9% by December-end (10.6% in Yen terms). These are very attractive gains in today's low interest environment, especially for Yen-based investors. We have been overweight global equities (except for one neutral quarter) since September 2011 and will remain so for now.
The SPX is now trading at 17.4 times NTM (next twelve month) bottom-up consensus earnings, which is 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. We do not believe further re-rating is possible now that bond yields are likely to rise moderately, but we think stocks can rise along with earnings. Importantly in that respect, we forecast that the SPX CY15 EPS is likely to outperform the bottom-up consensus estimate of 115 by 5%. We believe that bottom-up analysts have become too negative on the prospects of the US economy and the effect of the strong USD. Also, M&A and share buybacks should also support EPS growth as well as equity prices. All of this should drive the SPX to 2266 by December (although 3Q returns should be small as the market adapts to our more rapid Fed normalization path).
Eurozone equity prices stagnated in the 2Q, like we thought would occur, but the EUR rebounded vs. the US, so performance in USD terms was positive. We expect equities to rise in the next two quarters, but for the region to underperform due to a weaker EUR (leading to a 3.4% unanualized return in USD through December), so we will maintain our underweight stance on the region.
After a strong 1Q, Japanese equity market rose even further in the 2Q, but it was relatively flat vs. global equities in USD terms. In a fashion that has not been seen in a decade, Japan is much more appreciated now by both local and international investors. There remain some skeptics, but progress on the “big” third arrow of TPP and continued improvements in corporate profitability (which has now become quite a fad now) should dwindle their ranks further. As we have long reported in our “Show Me the Money” pieces, we believe that Abenomics is working well, especially for corporations, with 1Q pretax profit margins soaring to historical highs for both manufacturing and non-manufacturing sectors. It is, thus, working very well for equity investors too, and should continue to do so, in our view. Indeed, the market PER of 16.0 times our forward earnings estimate is attractive and consensus earnings estimates will likely continue to improve, partly due to a slightly weaker Yen but also due to the improving global economy. Thus, we expect 5% unannualized return in USD terms through December (TOPIX at 1753) and 8.4% in Yen terms.
In sum, we forecast, like last quarter, that Europe will underperform in the next six months, with the US, Japan and Asia Pac ex Japan performing the best and, thus, deserving overweight stances.
Greece and global geopolitics are the major risks to our view and we will continue to be ready to react to any major changes. 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 and that stocks can grow along with earnings due to: 1) a sturdy G-3 (plus China) macroeconomic backdrop that leads to stronger than expected corporate earnings; 2) continued accommodative central bank policies (although less so by the Fed); 3) relatively tame inflation that prevents bond yields from rising too far; 4) tamed geopolitical risks and 5) other supporting factors such as high global M&A activity and improved corporate governance in Europe and Japan. Coupled with our expectation for global bond yields to rise moderately, we maintain our overweight view on global equities vs. bonds.