Our forecasted macro-backdrop is positive overall for global equities, but only mildly so for those in the US. Indeed, aggregating our national forecasts from our base date of December 8th, we forecast that the MSCI World Total Return Index will increase 4.4% (unannualized) through June in USD terms (+7.1% in Yen terms) and 10% by year-end (14.6% in Yen terms). These are very attractive gains in today’s low interest environment, especially for Yen-based investors.
The SPX still trades at 16.6 times NTM (next twelve month) earnings, which seems a bit high in a historical context, but due to interest rates remaining structurally lower than any time since the 1950s, we believe this is a fair valuation. Indeed, we do not believe further re-rating is possible now that bond yields are likely to rise, but we think stocks can rise along with earnings through 2015. We are slightly less optimistic than consensus about earnings, greatly due to the negative translation effect of USD strength on overseas earnings and declining energy prices, but we expect SPX EPS to grow 7% in 2015, with M&A and share buybacks also supporting the market in the current low interest rate environment.
The Eurozone market is trading at 14.0 times 2015 earnings estimates, which looks attractive to us, especially as European companies have a highly globalized earnings profile and, thus, should benefit greatly from global growth. Similar to the US, we are not looking for a re-rating, but we believe that stocks can rise along with earnings, which should grow a strong 16% in 2015 and be supported by rising M&A activity, the ECB’s new QE policy and extremely low interest rates. The dividend yield of 3.3% also is very attractive given the extremely low bond yields in the region.
The Japanese market has risen in recent months, but this is primarily due to the weak Yen, and Japan has not outperformed global markets like we had expected. However, given the firm re-election of the LDP coalition, Abenomics has a major chance of accelerating and surprising skeptical investors. Moreover the BOJ and GPIF are expected to buy nearly 10 Trillion Yen of equities in 2015. Indeed, we believe that Abenomics is working well, especially for corporations (with pretax profit margins soaring to historical highs for both manufacturing and non-manufacturing sectors) and equity investors (at least in Yen terms), and that it will continue to do so. Indeed, the market PER of 15.5 NTM (next twelve months) earnings is very attractive especially as earnings estimates will likely continue to rise, partly due to the weak Yen but also due to the growing global economy and reduced skepticism by analysts. Regarding TPP, PM Abe has made it clear that he will do everything necessary for it to be successful and we estimate that it will pass the US Congress next spring. This is perhaps the most important part of the “third arrow” set of reforms, but a large number of other reforms have also been enacted “behind the headlines” due to their political sensitivity. Lastly, we continue to forecast that an equity culture is bound to develop in Japan, as remaining “risk free” will likely mean poverty in retirement, as both inflation and VAT rates are likely to rise over the intermediate and long term.
In the Asia-Pacific ex-Japan region, Australia is clearly being hurt by declining commodity prices, while Hong Kong is benefitting from increased confidence in Chinese reforms, as we expected in September. The rebound in commodity prices in 2015 should give spark to the former and Hong Kong should continue to benefit from Chinese reforms, but with Fed hikes likely being a moderate headwind due to the HK$ peg and the high sensitivity to interest rates among its listed companies.
As for regional preferences, we forecast that the US will underperform in the next six months, with Europe regaining some of its lost performance and Japan and performing the best. We also expect Asia Pac ex Japan to perform quite well, basically in line with global markets through June.
Contagion among emerging markets and within the high yield corporate debt arena (especially in the energy sector) are the greatest risks, in our view. Undoubtedly, geopolitics remains a significant risk factor and we will continue to be ready to react to any change in our view. Meanwhile, we have not commented about Ebola, even though only two months ago, it was quite frightening, but we have no reason to think it a major threat now. Lastly, Europe must be watched very carefully because the tail risk of a major downturn is far from negligible, especially if the Greek Presidential election results in the Syriza party gaining power via early elections.
Investment Strategy Concluding View
The investment world is changing quickly and 2015 should prove to be a very interesting year, but we see no reason to change our long-held positive view on global equities. In particular, we believe that equity valuations remain at fair levels (with some slight undervaluation in Europe and Japan) and that stocks can grow along with earnings due to: 1) a very firm US economy and rebounds in Japan and the Eurozone, greatly driven by lower oil prices, that will surprise many investors, 2) re-stimulation of the Chinese economy, 3) Fed “baby step” hikes that maintain a very positive backdrop for US equities and being accompanied by increased monetary accommodation by the ECB, BOJ and China, and 4) other supporting factors such as an acceleration of Abenomics in Japan and increased global M&A activity. These events, in turn, will, coupled with some Fed hikes, likely cause bond yields to rise moderately, so we maintain our overweight view on global equities vs. bonds, with a very constructive view on Japanese equities in particular.