Posted on SEP 14, 2017
Johnson Bank Wealth Weekly Investment Commentary | Thursday, September 14
This is part of an ongoing series of Weekly Commentary articles published by Johnson Financial Group.
This week's issue is written by Brian Andrew, SVP, Chief Investment Officer.
Earlier this week I had the opportunity to attend an investment conference given by one of our larger bond managers. An advantage of working with many talented investment managers is that we benefit from their expertise when making our own investment decisions. Their chief investment officer provided insights about the global economy and bond markets. While discussing the current state of global growth, she noted that we are in a period of “synchronized improvement throughout the world,” noting that growth has improved not only in the U.S., but most other parts of the world as well.
The globalization of trade is not a new concept. In fact it has been around for centuries (think the Silk Road and the rise of the British Empire). However, the idea of globalizing labor and information is much newer, having taken hold during the last 25 years. The ability to transport goods and services in real time allows global companies to use cheaper labor markets to produce goods and services. The information age has made it possible to work on service projects throughout all time zones so that work never really sleeps.
If we measure trade and transport activity, we can get an idea of how the global economy is performing. In the chart below, you can clearly see the increase in activity using the Goldman Sachs sea and airfreight indices as well as the CPB World Trade Monitor Index.
This increase in activity can also be seen in rising employment and economic growth rates around the world. In fact, the second quarter of 2017 was the first time in more than 10 years that the top 45 economies in the world were all experiencing growth! That's synchronized improvement. This increase in economic and business activity, then, results in greater profitability. As a result, the prices of stocks and corporate bonds have seen an increase throughout 2017. Corporate earnings and cash flow have generally improved, lifting investor sentiment about the prospects for future asset price increases.
The chart below provides estimates of earnings growth for different equity markets around the world using MSCI indices (MSCI is a purveyor of stock indexes on a global basis). The index is just a basket of stocks in the U.S., U.K. and so on. You can see that growth rates are consistently in the double digits for all markets. This is a result of the increasing global economic activity.
Two important things you'll notice are that earnings growth rates in most other markets are higher than those in the U.S., and the difference between the current estimate and the one from January of this year is higher in some cases, reflecting strengthening expectations. Where they have declined, it isn't by much. You'll note the largest decline in earnings expectations is in the U.S. (although a 10.6% growth rate is still very high). This fact is reflected in our general stock allocation view, which includes a significant portion of international investments.
For example, the U.S. has an expected growth rate of 10.6% (down more than 12% from the January expectation), the U.K. market has gone up to 20.6% from 14.1%, and Japan has gone up from 10.1% to 15.5%.
These numbers reflect future expectations resulting from the increase in economic and business activity we've experienced over the last nine months. When we look at these growth expectations through the lens of stock valuations, we can see that those markets with the higher growth expectations are actually relatively cheaper. As an example, the U.S. market, as measured by the S&P 500 Index, currently trades at 17.6 times earnings, while the Eurozone market trades at 14.0 times, and the Emerging Markets (EM) trade at 12.3 times.
Bear in mind that we aren't saying “cheap.” In fact, there are few asset classes that look cheap on a global basis. They look relatively less expensive given the prospective earnings growth and therefore warrant a larger allocation in our equity portfolios.
Monitoring global trade and economic activity is an important way to determine whether these earnings expectations will be met. For now, the synchronized improvement suggests that the economic rally will last for a while.
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy
to provide consistent, actionable investment solutions for our clients.
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