Global equity markets have been hit by a sharp and widespread correction in the current quarter. Following the low reached on August 8 (both in the US and in global markets), a day resembling a selling climax, when all 500 stocks in the S&P 500 ended down, markets have been carrying out a classic bottoming process that may be coming to an end. While periods of high volatility are likely to continue, we anticipate a moderate upward trend in global equity markets over the remainder of the year. There remain significant risks that could blow markets off this generally positive course.Global growth has clearly slowed. Nevertheless, we do not project a double-dip recession for the US or for the global economy. The US economy is likely to trudge along at roughly a 2% pace in the second half, clearly in positive territory but not rapid enough to achieve a significant reduction in the unemployment rate. Corporate profits are strong and continuing to increase, up by more than 100% from their 2009 lows, but business investment is up only 14%. The main restraining factors appear to be regulatory and tax uncertainties and lack of confidence in the macroeconomic outlook.
The recession risk is greater in Europe, where Greece, Ireland, and Portugal will by the end of this quarter have registered two consecutive quarters of negative growth. However, continued strength in the core economies of Germany, Netherlands, France, and Belgium should be sufficient to keep overall Eurozone growth in positive territory. The sovereign debt crisis still festers and maintains the potential to roil global markets. Action last Thursday by the European Central Bank, in coordination with the US Fed, the Bank of England, the Bank of Japan, and the Swiss National Bank, to provide US dollar liquidity with three-month maturity to Eurozone banks assured markets that liquidity needs of those banks will be covered through year end. Markets also were buoyed by strong statements from the leaders of France and Germany, stressing their commitment to the euro and to keeping Greece in the Eurozone. Over the weekend, however, a meeting of the European Finance Ministers decided to postpone until their next meeting in early October a decision on the release of a scheduled 8-billion euro payment to Greece. They wish to see Greece make better progress in meeting its commitments for budgetary improvements and other reforms. Markets will also be looking towards the vote of the German Bundestag on enhancements to the European Financial Stability Facility (EFSF) at the end of this month.
In Asia, Japan’s economy, after a strong surge in the current quarter, is expected to moderate to a more normal 2.5% growth in the coming quarters. China is on track for engineering a soft landing from the very rapid growth of recent years and will remain the global growth leader, an important bullish factor for global markets, Asian markets, and commodity exporters in particular. One regional beneficiary is Australia, where the economy is expected to continue to register 4+% growth.
At Cumberland Advisors, our International and Global Multi-Asset Class portfolios are fully invested. We remain underweight in Europe, where the risks posed by the sovereign debt crisis still look significant. Bank stocks, which constitute important parts of European equity markets, remain a particular concern. For that reason, we have been attracted to the WisdomTree International Dividend Ex-Financials ETF, DOO, that tracks an index of high-dividend-yielding international stocks outside the financial sector. In comparison with the -12.6% year-to-date decline in the iShares ETF, EFA, which tracks the benchmark MSCI EAFE Index of advanced markets outside of North America, the DOO ETF has lost 8.3% year-to-date.
Advanced-market ETFs in the Asia-Pacific region (Australia, New Zealand, Japan, Hong Kong, and Singapore) are expected to continue to outperform. Notably, the New Zealand equity market is the only advanced-economy market that has registered a positive year-to-date return, +14.53%, according to the MSCI equity market index for that market.
The Asian region is also our preference for emerging-market investments. Emerging markets underperformed as a group in the first half. Over the last month, however, they have begun to register better performance than the advanced-economy markets. We expect emerging-market and commodity-exporting countries to return to leading the global economic recovery. As a group, emerging-market economic growth will continue to be at three times the pace of advanced economies. Emerging-market valuations are cheap, with the valuation of the stocks in the MSCI emerging-market index now at levels last seen in 2003.
It is likely that selectivity among the emerging markets will continue to be important for performance. Thus far this year the MSCI index for Asian emerging markets lost 12.4%, compared with a 15% loss for Latin American emerging markets. Within Latin America, the little market of Colombia has registered a surprising positive 4% year-to-date return, in sharp contrast to declines of 16.8% in Brazil, 17.2% in Chile, and 17.9% in Peru. Mexico fared a little better with its 10.5% drop. Going forward, we think Peru, Mexico, and Columbia should perform relatively well.
In Asia Indonesia has been the strongest performer, with a positive 7.8% year-to-date advance. We are concerned that Indonesia, because of its exceptional performance, may be somewhat overbought; but its commodity exports, particularly in energy, should continue to underpin this market. In contrast, China’s equity markets have underperformed thus far this year, despite China’s globe-leading economic growth. The SPDR S&P China ETF is down 12.3%. Going forward, China should be able to register at least benchmark performance. Malaysia, Taiwan, Thailand, and the Philippines have all outperformed the emerging-market benchmark over the past three months, and in September India has returned to the outperformance group. In other regions, Russia and South Africa have outperformed year-to-date, each benefiting from their commodity exports. Recently, Turkey’s market has recovered from its earlier sharp decline.
In sum, the various opportunities in emerging markets are looking increasingly attractive. Along with their relative strong growth, they are characterised by strong external-reserve positions and have fiscal situations that in most cases are considerably better than those of major advanced markets. But it is important to bear in mind that these markets remain vulnerable to any global pullbacks in willingness to accept risk.
Bill Witherell, Chief Global Economist
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