Could the Rally in Global Equities Keep Rolling?
Although global equity markets have rallied recently, some investors may feel unsettled about the changes occurring in many parts of the world—and what those changes could mean for their portfolios. While Cindy Sweeting, director of portfolio management, Templeton Global Equity Group, says investors’ concerns are well placed, she has found reasons to be optimistic amid the shifting landscape. Join Sweeting for a virtual around-the-world tour where she presents the factors—both the favorable and the foreboding—that she believes may sway stock performance going forward.
A continuation of the rally in equities globally and growing confidence in the forward-earnings power of more economically sensitive value stocks will likely depend on continued improvement in global economic growth and, consequently, improving prospects for profit margins and earnings.
It will also likely depend on a successful transfer of the policy baton from a world where extraordinary monetary measures have been the primary (if not the sole) policy underpinning attempts to reflate the global economy out of the excess leverage, low-investment, low-growth and low-productivity limbo it has been mired in for some time.
As we saw in 2016, interest-rate repression down to zero and into negative-rate territory has had some significant and unintended adverse consequences, which may have exacerbated a deflationary mindset, causing higher savings and lower spending from both consumers and corporates. It has also handicapped the financial sector overall, and the banking sector in particular, to the detriment of both their profitability and their ability and willingness to create credit.
Given that backdrop, we can understand the market’s enthusiasm for supportive fiscal policy measures, pro-growth tax reform and a more normal interest-rate environment, which would, in our view, improve corporate confidence and lead to increased investment.
We believe higher investment spending would, in turn, better underpin longer-term global economic prospects, improve weak productivity and bolster both corporate earnings and equity valuations. It’s a tall order for such a regime change, but the market so far seems to be enthusiastic about the prospects.
In the United States, market performance going forward will likely depend on President Donald Trump’s anticipated pro-growth policies actually coming to fruition. These policies include lower corporate taxes and overall tax reform, infrastructure spending, investment incentives and rollback of regulation, along with a gradual normalization of interest rates from still-low levels. We believe this all would need to occur, however, without detrimental protectionist policies that could potentially dampen growth and invite retaliation.
US stock valuations are not cheap, and the market has been highly anticipatory that pro-growth and reflation policies are right around the corner. So, some pause in the market’s level of optimism may be expected.
China: The Deal with Its Debt
Looking internationally, China, in our view, needs to take measures to tackle its corporate debt problems before they become a major drag on sustainable growth in the world’s second-largest economy. Many investors are now aware of the dimensions of China’s debt, which we have noted and analyzed for some time, and the problems it has precipitated.
These include overbuilding in real estate and an overhang of unsold properties, especially in lower-tier cities, along with excess capacity in related industries such as steel, cement and coal.
The combination of heavy borrowing and falling profits and cash flow led to excessive debt loads. This has become evident particularly among state-owned enterprises that benefited from preferential access to financing and implicit government guarantees, which lowered their cost of borrowing and incented them to keep on adding leverage.