What markets have room to grow? When might volatility reappear? How do bonds look relative to equities for the next six months? Where are the opportunities? Varying views on global markets are expressed by investment professionals from across Natixis Investment Managers in this midyear outlook.
OUR PANEL RESPONSES
DAVID G. HERRO CFA®
Deputy Chairman, Portfolio Manager and CIO – International Equity
The stage is set, I believe, for increased rates of global economic growth as we continue into the second half of the year. Such growth should provide a boost for corporate earnings and share prices given current valuations, which still seem relatively attractive.
Global equity markets have marched higher thus far in 2017 (as of June 14) as economic activity continues to strengthen. The Dow Jones Industrial Average is about to notch its seventh consecutive quarterly gain, and the STOXX Europe 600 Index is expected to advance for the fourth quarter in a row. The U.S. personal consumption expenditures (PCE) index surpassed the Federal Reserve’s long-term target in February. The euro zone’s own annual rate of inflation also reached the European Central Bank’s 2% target in February for the first time in four years. Citing improvements to the labor market and economic health, the Fed lifted interest rates in the U.S. on June 14, for the third time since December. It appears on track for one more rate hike in 2017, as well. We also see a strong global consumer, who has been supported by low unemployment, low energy prices and low interest rates thus far. Business confidence appears to be on the rise, as well. I think a lot of this has been driving share prices, not just in the United States but globally.
Europe, in particular, seems to finally be coming out of its economic doldrums. We are starting to see better rates of growth. It’s not robust, but it’s growing a little better. The banking system is also showing real signs of recovery. While we have seen a rebound in European equities in 2017, they still trade at a discount to U.S. equities. I’ve always believed that they should trade at a greater discount given the differences and return structure of European companies versus U.S. ones. But today’s discounts may still be too high in certain areas.
Politics as usual
Certainly, we have witnessed a lot of political drama around the globe in recent months. However, at Harris Associates, we look at political events as white noise. We expect the impact to cash flow should be minimal. Though political uncertainty can create volatility, we view it as an opportunity to purchase quality companies at what we believe are attractive prices.
Geopolitical risks are a constant
Since I began my investment career in 1986, I can barely remember a time when there wasn’t some risk looming: we had a stock market crash in 1987. The Gulf War in 1990, The Iraq War in 2003, the conflict in Ukraine in 2014, and so on. As long-term investors, we just have to realize that these risks are always with us. Again, for the most part, we view these macro events as white noise. They often create lots of fear and volatility, which might impact short-term earnings. However, long-term earnings streams may not be impacted much.
As always, the short term is difficult to predict, and may have little influence on a business’s value.
David G. Herro, CFA®
David Herro is the Chief Investment Officer – International Equities at Harris Associates L.P. and serves as a Deputy Chairman and a Portfolio Manager of a number of Oakmark funds. He was named Morningstar’s International–Stock Fund Manager of the Decade for 2000-2009 and Morningstar’s International–Stock Fund Manager of the Year for 2016.* Mr. Herro has been managing international portfolios since 1986, previously managing international portfolios for The State of Wisconsin Investment Board and The Principal Financial Group.
Mr. Herro, who joined Harris Associates in 1992, holds a BS in business and economics from the University of Wisconsin – Platteville (1983) and an MA in economics from the University of Wisconsin – Milwaukee (1985). He is a CFA® charterholder.
*According to Morningstar: The Fund Manager of the Year award recognize portfolio managers who demonstrate excellent investment skill and the courage to differ from the consensus to benefit investors. The Fund Manager of the Year winners are chosen based on Morningstar’s proprietary research and an in-depth evaluation by its manager research analyst team. Up to five awards are given every year for managers from each of the following asset classes: Domestic Stock, International Stock, Fixed Income, Allocation, and Alternatives. To be eligible for the award, managers must run funds that are under Morningstar manager research analyst coverage, which includes approximately 1,200 open-end U.S. funds, and have received a Morningstar Analyst Rating™ of Gold, Silver, or Bronze over the past 12 months. To be nominated, managers must not only have posted impressive returns for the year, but also have a long-term record of delivering outstanding risk-adjusted performance and aligning their interests with those of shareholders. Nominations are made by Morningstar manager research analysts, then narrowed to a list of finalists by a nominating committee. The entire analyst team meets to debate the merits of the finalists in each asset class. Voting commences immediately after each asset-class meeting, and nominees receiving the most votes are the winners.
According to Morningstar: The Fund Manager of the Decade award recognizes fund managers who have achieved superior risk-adjusted results over the noted 10-year period and have an established record of serving shareholders well. While the awards focus on performance over the past decade, Morningstar takes into consideration other factors, including the fund manager’s strategy, approach to risk, size of the fund, and stewardship. Both individual fund managers and management teams are eligible, and being a previous winner of the Morningstar Fund Manager of the Year award isn’t a prerequisite. Morningstar’s fund analysts select the Fund Manager of the Decade award winners based on Morningstar’s proprietary research and in-depth evaluation.
DAVID LAFFERTY CFA®
Senior Vice President and Chief Market Strategist
Natixis Investment Managers — U.S. Distribution
As we move into the second half of 2017, there is a sneaking suspicion among investors that something is askew. While the market news flow is heavy, the markets themselves are eerily quiet. Realized and implied volatilities across global stocks, bonds, and currencies are near all-time lows. Global stocks continue to move higher but few investors believe in this rally wholeheartedly. Adding to the confusion is the modest rally we’ve seen in global bonds, with yields falling from their March peak. Should stocks (risk assets) and high-quality bonds (relatively safer assets) be rising at the same time? And which market is foreshadowing the true outlook for the global economy? Maybe both. We believe the investment environment today is characterized by two countervailing forces: improving fundamentals offset by relatively high valuations. This combination of forces is prompting both investor apathy and low market volatility.
Fundamental support, valuation pressure
The fundamental side of the global economy appears to be picking up steam. Activity metrics such as the Purchasing Managers Indexes (PMIs) are now experiencing a synchronized expansion across the U.S., Europe, and emerging markets for the first time in years. After a soft Q1, U.S. GDP is expected to grow at close to 3.0% in Q2 and just over 2% for the full years of 2017-18.1 Likewise, Europe is awakening from its slumber. Real GDP is approaching 2%, unemployment is falling, credit demand is rising and the fear of deflation is waning. Emerging markets are gaining traction paced by China, where the growth rate has stabilized in the last year, and India, which is rebounding well from demonetization.3 Consistent with stronger global growth, corporate earnings estimates are rising, creating fundamental support under risk assets like stocks and corporate bonds – hardly a bearish background as we move into 2H:2017.
Not to be forgotten is that behind this economic environment, asset valuation is far from compelling. No broad asset classes that we can identify are “pound the table” cheap. Depending on which central banks you want to include, global quantitative easing (QE) programs have added $14 to $18 trillion in assets to the banking and financial system. This has resulted in equity valuations that are extended (but not exorbitant) globally while both interest rates and credit spreads remain low across the bond market. As a result, asset prices are compressed into a trading range, supported from below by improving fundamentals but limited in their upside by stretched valuations. This has in turn led to generally declining levels of volatility across most asset classes since mid-2016.
Caught between improving fundamentals and constraining valuations, the global equity markets should offer positive returns moving into the second half of 2017 and into 2018. However, this return will be predicated on “clipping the coupon” (an expression usually reserved for bonds) of earnings growth, not a broad expansion of price-to-earnings (P/E) levels. In bonds, the massive dislocation between negative interest rates (expensive high-quality bonds) and wide credit spreads (cheap corporate bonds) in early/mid-2016 has largely been eliminated. With yields quite low, investors may still want to consider the additional carry available across the corporate sectors of the bond markets. However, prudence should still prevail as we get later in the credit cycle.
Periods of abnormally low volatility cannot persist forever. While we see little evidence of systemic risks in the global economy, we expect the remainder of 2017 will offer some negative surprises and increased volatility. Assuming these setbacks don’t undermine the upward trend in economic activity, they may provide a chance to rebalance into better valuations.
David Lafferty, CFA®
David Lafferty is Senior Vice President and Chief Market Strategist at Natixis Investment Managers. He is responsible for assessing economic and capital market trends and their implications for investment portfolios. His team also works with affiliated asset managers to develop portfolio insights. He has been with Natixis since 2004. Previously, Mr. Lafferty was senior vice president responsible for fixed-income and asset allocation products at State Street Research & Management, developing investment strategies for institutional clients with assets ranging from $10 million to $2 billion. From 1998 to 2001, he was a senior investment strategist at MetLife, structuring asset allocation programs for institutional clients with assets totaling $600 million. From 2008 to 2012, he served on the Board of Directors of Caspian Capital Management/Caspian Private Equity, a New York based hedge fund and private equity firm.
Mr. Lafferty is a frequent speaker at industry events and is often quoted in Barron’s, Bloomberg, The Wall Street Journal and other financial publications. He received his BA from the University of New Hampshire and his MSF (Master of Science in Finance) from Suffolk University. He is a member of the Boston Security Analyst Society, the CFA Institute, and the National Association for Business Economics (NABE) and has more than 20 years of investment industry experience.
1 Bloomberg consensus estimates
Clipping the coupon refers to a time when bonds were issued in the form of bearer certificates. Physical possession of the certificate was proof of ownership. Coupons, one for each scheduled interest payment over the life of the bond, were printed on the certificate. At the date the coupon was due, the owner would detach the coupon and present it for payment (an act called “clipping the coupon”).
Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
Price-to-earnings (P/E) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
Risk asset generally refers to assets that have a significant degree of price volatility, such as stocks, commodities, high-yield bonds, real estate and currencies.
STOXX Europe 600 represents large, mid- and small capitalization companies across 17 countries of the European region.
Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.
All Investments carry risk, including risk of loss.
Equity securities are volatile and can decline significantly in response to broad market and economic conditions.
Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency and information risks. Foreign securities may be subject to higher volatility than U.S. securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets.
Fixed-income securities/Bonds may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
Indices are unmanaged and do not incur fees. It is not possible to invest in an index. The selected indexes are not intended to represent a particular fund or investment
CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.
The views and opinions expressed are as of 6/27/2017 and may change based on market and other conditions.
This material is provided for informational purposes only and should not be construed as investment advice. References to specific securities, sectors or industries should not be considered a recommendation.