2015 Q3 House Views Update
by Nikko Asset Management's Global Investment Committee
- G-3 Economies Should Continue Relatively Firm
- Our logic for the Fed hiking in October and thereafter
- Forecasting a Stronger USD and Higher Bond Yields
Our forecasted macro-backdrop scenario has mixed ramifications for global equities, with the US declining but most other regions rising, and it is likely to be very volatile ride. Aggregating our national forecasts from our base date of September 11th, we forecast that the MSCI World Total Return Index will decrease 0.4% (unannualized) through December in USD terms (+1.6% in Yen terms) but increase 1.9% by March-end (4.7% in Yen terms). These gains in USD terms are not attractive enough to justify an aggressive stance on global equities except for Yen-based investors. We have been overweight global equities for USD-based investors (except for one neutral quarter) since September 2011 but now believe that neutral is the proper stance.
The SPX is now trading at 16.5 times NTM (next twelve month) bottom-up consensus earnings, which is high in a historical context (and if one fully expenses for option grants, the PE is probably a full point higher), and although interest rates are structurally low, we now expect a slight de-rating since bond yields are likely to rise and given a softer earnings outlook. Indeed, the sharp decline in oil prices and further deceleration in many emerging market economies (with much weaker currencies vs. the USD), we forecast that US corporate earnings will not increase as much as we previously expected. All of this should drive the SPX to 1897 in end-December and 1935 by end-March, as the market adapts to the Fed normalization path.
Eurozone equity prices should rebound after two quarters of weakness, with rising corporate earnings and continued regional economic growth being the main factors. Even though the EUR in our forecast weakens vs. the USD, we expect a 2.9% unannualized return in USD through December and 5.1% through March, so we will move to an overweight stance after two successful quarters of underweighting.
After Japanese equities’ weak 3Q, which saw a dramatic de-rating, we expect the market to rise with earnings in the next two quarters. Firstly, there will likely be progress on the most important third arrow, TPP, which will increase confidence in continued reforms. Even though Japan’s economy might not be very strong, this should not concern investors greatly. As we have long reported in our “Show Me the Money” pieces, we believe that Abenomics is working well, especially for corporations, with 2Q pretax profit margins soaring to historical highs for both manufacturing and non-manufacturing sectors. It is, thus, working very well for equity investors too, and should continue to do so, in our view. Indeed, the market PER of 14.0 times our forward earnings estimate is attractive and consensus earnings estimates will likely continue to improve, partly due to a slightly weaker Yen but also due to the moderately improving global economy. Thus, we expect a 3.9% unannualized return in USD terms through December (TOPIX at 1560) and 5.5% through March (5.9% and 8.5%, respectively, in Yen terms).
As for Asia Pacific, we expect continued weakness in Hong Kong equities (MSCI Hong Kong is nearly completely oriented to non-Mainland shares) due to rising US interest rates and troubles in the domestic economy, but our view on Australian equities is fairly quite positive.
In sum, we forecast that Japan and Europe will outperform in the next six months, with the US underperforming and, thus, deserving a major underweight stance. Asia Pac ex Japan shows mixed results and should only be slightly underweight.
The largest risk now is emerging market economic growth, but Greece and global geopolitics remain significant risks. Within emerging markets, corporations with large USD debts pose credit risks, especially as credit ratings decline. The large debts within the US shale oil sector are also likely to worsen substantially in the coming quarters unless oil prices rebound. This may also impact US economic growth, and weakness in the oil patch is already creating a risk that 3Q GDP growth may surprise on the downside.
Investment Strategy Concluding View
We calculate that global equity valuations are at reasonably fair levels and that stocks can rise in Europe, Japan and Australia, but because we are less optimistic on the US, we do not think it is worthwhile, especially with the recently increased volatility, to be aggressive on global equities overall. Coupled with our expectation for global bond yields to rise moderately, we reduce our stance on global equities to neutral for USD-based investors and underweight global bonds vs. USD cash.