The world economy is evidently in the midst of what many are calling a synchronised upswing in growth. A strong rebound in manufacturing, led by Europe, appears to be at the heart of the resurgence. And the pace of expansion has accelerated in recent months. This environment is fundamentally conducive to outperformance by assets leveraged to global growth.
Investors have now been uneasy for many months that in some key global equity markets, shares are becoming overvalued, with share prices relative to corporate earnings – P/E ratios ¬– stretched, especially in the United States.
But our analysis concludes that equity earnings cycles, especially in underperforming markets in Europe and emerging markets (EM), should continue to power ahead for some time.Global trade growth, which typically follows global manufacturing growth with a lag, is central to our constructive story on emerging markets. At the same time, expensive markets in developed economies are, for now, unlikely to suffer a correction in this environment. Instead, valuations are likely to get more expensive.
Goldilocks sees off the bears
In our view, this is a what we call a “synchronised goldilocks environment” – one where strong growth with relatively muted inflation for much of the world means that conditions for markets are neither “too hot” nor “too cold” across most of the globe.
While we do see indications of some pick-up in global inflation, we still struggle to find any case for a breakout of inflation that might spook bond markets.
At the same time, present relative weakness in the US dollar can also be a significant reflationary boost to world growth and inflation, helping the favourable environment in global markets.
While inflation is likely to pick up overall it is modestly firming in some places, but likely to decline further in others. Along with the structural forces depressing global inflation, this means that the ultimate rates of inflation worldwide during the present global upswing are likely to be fairly modest.
Earnings cycles are likely to be extended
So while equity earnings momentum has already been strong for some time, the present reacceleration in growth suggests this could continue for a while. Earnings growth is on an upward trajectory in most markets. And while analysts have become cautious about the outlook over the coming quarters, the resurgence in global activity suggests that the inflexion point in earnings cycles is likely delayed.
This “goldilocks” scenario is positive for global equities, but still doesn’t imply a rout in bonds. We only expect a modest repricing higher in global bond yields rather than an all-out rout.
In emerging markets, to the extent that EM assets are a view on global growth, the recent sell-off is probably an opportunity to buy. It’s unlikely that EM equities will suffer in an environment of accelerating manufacturing activity. The surprise isn’t that EM equity performance has been strong this year – it’s that it hasn’t been stronger relative to global manufacturing activity.
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