Market Outlook Q3 2019: Equities are back on the upswing

After the best start to the year in nearly three decades, global equity markets have been on a roller coaster ride lately as political and trade uncertainties are keeping markets on their toes. However, the fundamental backdrop remains constructive for equity investors and we see further upside in the months ahead.

The outlook for the global economy is better than many believe
The fundamental backdrop remains constructive for equity investors. The global economy is expanding at a moderate growth rate. While manufacturing is finding its way out of a rough patch, economic activity is well supported by nominal wage growth in excess of 5% in the United States and 3% in the eurozone. This is important as consumer spending makes up nearly 70% of the US and over 50% of the European Union’s economy. In China, government-led stimulus – via tax cuts, spending increases and interest rate cuts - is a strong counterbalance to trade-related uncertainties and weaker economic data. Importantly, from an equity perspective, the US Federal Reserve has indicated that it could open the liquidity gates, as have other central banks, even if only as a precautionary move given the trade uncertainties. Such a move could well lengthen the current growth phase and provide further fuel for equities.

Cyclicals have the wind in their sails
The ongoing economic expansion coupled with ample liquidity provisions from generous central banks should lead to rising bond yields, especially in the US. These would typically support cyclical versus defensive stocks. Cyclical stocks are also attractively valued given their growth profile and the fact that earnings are being revised upward.

Strong US wage and employment growth favour cyclical stocks Source: Thomson Reuters Datastream, Julius Baer Fixed Income Research

We see attractive opportunities in the following cyclical segments of the market: Industrials are attractively valued and are benefitting from investment-led growth as companies are expanding capacity. They are also a beneficiary of increased automation across industries. Internet communication companies are revolutionising how we interact with each other. Concerns about antitrust investigations and privacy issues have weighed on the performance of this group lately. This means, in our view, that they now offer compelling value over the medium to long term. Last, but not least, we continue to see opportunities in materials. The performance of this sector is highly dependent on China’s growth. Thus, investing in material stocks can be a way to gain exposure to China for those who do not want to invest directly in the Middle Kingdom. The sector is also attractively valued on virtually all relevant valuation metrics, which are currently below historical averages.

China is the elephant in the room when it comes to emerging market equities 
Within emerging markets, China is our preferred equity market. The CSI 300 Index gained in excess of 30% in the first four months of 2019. Since early May, it has been consolidating as trade concerns are rising and growth remains subdued. Going forward, we view Chinese equities as strategically and tactically attractive for global portfolios.
From a strategic perspective, China is the least correlated equity market to the S&P 500 among major indices, not least due to the fact that it has a large internal economy fuelled by a growing middle class. The Chinese equity market is also too large to ignore when it comes to investing in emerging market equities. Chinese equities make up more than 30% of the MSCI Emerging Market Index. Importantly, the performance of the Chinese stock market reverberates around the globe, which is not the case with other emerging markets.
From a tactical perspective, earnings growth expectations seem to have found a bottom and are even turning positive again for China. The Chinese government is actively supporting the economy via a loosening of monetary conditions and increased government stimulus.

A weaker US Dollar in the second half of 2019 could provide further tailwinds for emerging market and Chinese equities. They have historically performed well when the US Dollar was weakening as it implies that the world’s reserve currency is in ample supply for companies around the world.
A full-blown trade war might be damaging in the short term but longer term could well increase the fundamental diversification merits of Chinese equities. Thus, we think this favours a stock-picking approach to investing in the Chinese market given its strong long-term fundamentals.

The Oscar for the best performing market of the last twelve months goes to …
…Switzerland, a safe-haven market thanks to defensive heavy weights in its major indices. In fact, given the geopolitical risks and trade tensions, sectors with defensive characteristics could become more enticing. On a global perspective, the oil & gas and healthcare sector are attractively valued. The oil & gas sector is the only ‘pure value’ case in equity town and stocks in the sector trade at record-high dividend yields, both relative to their own history and compared with the broad market. When it comes to healthcare, its defensive characteristic seems quite obvious as we all want to be healthy irrespective of whether the economy is booming, or not. Yet, healthcare also provides exposure to the ageing population, big data and increased demand in emerging markets.

Global equities: Not expensive based on earnings projections Source: Refinitiv, Credit Suisse Research, Julius Baer Equity Research

The environment remains constructive for equities given the ongoing economic expansion coupled with ample liquidity provisions from generous central banks. We expect the global economy to grow by 6% this and next year combined. With this background in mind, we continue to like equities as an asset class. Those looking to give some flavour to their portfolio may want to look at cyclical stocks, although we are also starting to find value in defensive sectors. When it comes to emerging markets, China is the way to go. 

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