MARKET COMMENTARY

Global Opportunities, at Home and Abroad

06.19.2017 - Carin L. Pai, CFA

EQUITIES OVERVIEW

The global economy continues to improve, with better-than-expected earnings in the first quarter, stronger GDP data and political stability across many developed and emerging markets. These improvements have broad implications for equity investors: Over the next several years, it appears that the most attractive returns could come from markets outside the US, especially regions that have recently crossed the threshold from economic contraction to expansion.

Opportunities at Home

In the US, we have been seeing improvements among companies with broad international exposure. In fact, the S&P 500 is dominated by multinationals that earn an average of 40% of their profits outside the United States. For example, the industrials sector saw improvements in sales and profits thanks to an uptick in manufacturing, more stable oil prices and stronger demand from emerging markets.

Another beneficiary of global economic growth could be the tech sector, which has broad exposure to the global economy. The Philadelphia Federal Reserve reported recently that nearly 52% of manufacturing firms intend to increase their capital expenditures this year, with more than a third of those companies citing the need to modernize their information technology systems as a motivating factor. Government spending, which has been constrained for years, could provide an additional lift. In May, President Trump issued an executive order to begin modernizing IT systems in government agencies.

Opportunities Overseas

In our view, markets that appear to be transitioning into the early stages of an economic growth cycle offer more attractive market appreciation potential than we currently see in the US, where the cycle looks more mature.

In Japan, GDP grew for its longest stretch in thirty years, unemployment fell to a 20-year low and earnings improved at double-digit rates. These upturns contributed to a surge in the Japanese equity market, which returned 80% on a cumulative basis over the past three years. Japanese stocks have been trading at a forward price-to-earnings ratio of roughly 14, compared to 17.5 for the S&P 500.

In Europe, where interest rates remain low and wage pressures modest, we are increasing our exposure to large-cap companies with attractive valuations, healthy balance sheets and strong management. Earlier this year, European GDP growth outpaced the US for the first time since 2008. European stocks have also been trading at a discount, with a forward price-to-earnings ratio of roughly 12.

Buying On Weakness

While a stronger economy is lifting global markets, we are also mindful of the risks. In the US, just 10 stocks were responsible for the S&P’s gain of 0.9% in April, indicating that expectations for economic growth here at home may already be priced into the market. This level of concentration could limit the potential for market appreciation over the next several months.

On the international stage, the benefits of China’s economic stimulus measures have started to fade, which could lead to a pullback in global equity prices. The good news is that investors appear to be waiting on the sidelines for weakness in the market and would likely become buyers if the market consolidates. In our view, a combination of strong economic fundamentals and money on the sidelines could prevent a temporary pullback from escalating into a longer-term correction.

Finally, it is worth pointing out that we also stand ready to buy on weakness. As the global economy appears ready to transition from recovery to expansion, we expect a rotation away from defensive sectors like consumer staples, telecom and utilities toward cyclical industries like industrials, financials and technology. We also prefer US companies that participate in the global supply chain over companies focused on the domestic market (see CHART). We are positioning our portfolios accordingly.






This communication is intended solely to provide general information. The information and opinions stated are as of June 19, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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