Jefferies

Economics and Strategy

Bouncing Back

— Sean Darby, Global Head of Equity Strategy

After a strong rally in early January, global shares succumbed to a melt up in the VIX index in February. Nevertheless, global equities regained their poise quickly as fears subsided over any contagion while the dollar was subdued. In retrospect, equity indices simply became overbought at a time when U.S. bond yields were rising. Ironically, global growth continues to firm while sales and earnings revisions have remained healthy. It is interesting to note that global emerging markets – normally the most sensitive to changes in risk appetite – actually outperformed the S&P 500 post the correction.

There is still good news for S&P 500 international revenue generators. Firstly, both the IMF and World Bank in January revised up their Global GDP projections. Secondly, global sales projections are soaring, helped by the U.S., China and Japan. Thirdly, the dollar has been weak both nominally and real. Lastly, stock baskets of high overseas earners have outperformed domestic ones.

The Philadelphia Capex Intentions Index has remained at its most elevated level since the 1970s. Equally, small business optimism is rising while construction indices are just shy of all-time highs, and technology-leading indicators are still firming. Coupled with a turnaround in mining and oil investment as well as improving overseas investment trends, it is possibly one of the best ever environments for U.S. capex.

According to the Chinese Zodiac, the Dog is the symbol of loyalty and honesty. Similarly, investors will be expecting a third consecutive year of Chinese corporate profit growth and record high free cash flow. China GDP growth will moderate while monetary policy may see some modest tightening. Yi Gang, the deputy PBOC Governor, will assume the reins of the Chinese central bank once the current Head Zhou Xiaochuan retires after fifteen years at the helm. We remain Bullish on Chinese equities.

There seems to be several misconceptions about the environment for Japanese equities at present. A regime shift occurred in September 2016 when the Bank of Japan adopted Yield Curve Control (YCC). Whether by design or chance, the results have been much better than consensus had estimated. Indeed, it could be argued that conditions remain very favorable despite the apparent ‘strength of the Yen.’

In Europe, it is clear that Germany is experiencing inflation. German equities offer a wide population of stocks either offering quality-at-a-reasonable price, value or growth attributes. We remain Bullish on Germany within our Global Asset Allocation.

The bottom line is that rate normalization was always going to bring about the return of volatility. Corporate balance sheets are healthy and companies are seeing improving earnings and FCF generation. Global equities are well placed to show modest absolute returns.