5 charts

Regime shift

US stocks have outperformed their global and emerging counterparts by a mile in the last ten years. But this hasn’t always been the case. For example, in the decade prior to that, the S&P 500 Index realized a negative return while emerging markets skyrocketed 188%. So what about the ten years to come? Given the lofty valuation of US stocks, the CAPE being above 30, stock markets outside the US may well outperform. That said, the performance gap between US and the rest of the world can partly be explained by the US being home to a number of technology firms that have reshaped many aspects of daily life. This is not something that will shift overnight.

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Is the manufacturing glass half full or half empty?

Global manufacturing stabilized in October, ending ongoing decline as trade tensions rose and global growth slowed. However, the manufacturing PMI for developed markets remained firmly below 50 in October, marking the sixth consecutive reading below that threshold. For emerging markets, things look slightly more upbeat with a PMI of 51, but are still far from exuberant. So where to from here? Based on several indicators like steeper yield curves, rising money supply growth, and easier monetary policy , the odds are that the Manufacturing PMIs will recover further from here. This could be a swing factor for global earnings as well. Do not expect manufacturing to the main growth-driving force, however, as that would require a material deal on trade.

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Why European equities have lagged

Equities have generated tremendous returns since the height of the global financial crisis. But the gap between regions is large – very large. The return difference between US and Eurozone stocks since the low in 2009 is more than 280%. So what is behind this massive divergence?

First, earnings per share growth of US-listed companies has been much higher than that of Eurozone companies.

Second, related to the above, the stellar rise of technology companies (e.g. Amazon, Apple, Facebook, Google and Netflix) which are mainly domiciled in the US.

Third, politics. Ever since the financial crisis, Eurozone stock markets have been plagued by political issues like the peripheral debt crisis, Euroscepticism and Brexit.

Fourth, an interesting alternative, the US 401(K) tax-deferred pension plan, which has been propping up US stock markets. Josh Brown from Ritholtz Wealth Management points out that US 401(k) plans have a combined value of USD 5.8 trillion, and that people kept contributing to their plans throughout the crisis.

Fifth, valuations of US stocks have risen relative to those of Eurozone stocks.

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32 percent!

The MSCI World Total Return Index is up a staggering 32% in EUR from its low of late December last year. Obviously, as we approach December, the massive surge in equities is giving some investors the jitters. And while some temporary downward pressure should not be ruled out – for example, because the phase 1 trade ‘deal’ between the US and China hits a roadblock – one thing is clearly different from last year. The Federal Reserve hiked rates for the fourth time in December 2018, which in retrospect was a policy mistake. Since then, it has lowered rates three times, announced balance sheet expansion, and basically ruled out any tightening in the foreseeable future. This should soothe at least some of the jitters.

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Bond yields have shot up this week, with the US 10-year Treasury yield rising from 1.67% to as high as 1.97%, before coming down slightly. The German 10-year Bund yield is up almost 20 basis points to -0.23%. Will bond prices fall into the abyss from here? I don’t think so. We have been here before. While there are good reasons to believe that bond yields will eventually move higher, a swift and painful move back to more normal bond yields seems out of the question. Central banks like the ECB and the Federal Reserve will not ease much more if economic conditions hold up, but they still have a very accommodative stance. In addition, inflation expectations have been creeping up lately but remain far from target levels, especially outside the US. GDP growth is expected to pick up in the first half of next year but will stay below trend. So, a number of factors imply that bond yields are likely to stay low for the foreseeable future, but recent developments are a not-so-gentle reminder that duration risk works both ways.

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