World Markets Are Ready for Comeback as ’America First’ Seen Fading
(Bloomberg) -- Don’t sleep on the rest of the world, even as the U.S. keeps setting stock-market records.
That’s the message coming from a host of Wall Street shops highlighting the potential for the America-first thrust in financial markets to reverse. While major U.S. benchmarks rallied to fresh highs Thursday, gains in global equities have been even steeper this week, headlined by a 3.4 percent advance in Japan’s Nikkei 225 Index after a 3.5 percent jump last week.
The convergence across global assets will persist, say the chorus that includes BlackRock Inc., Bank of America Corp., JPMorgan Chase & Co. and Eaton Vance Corp. The strategists point to a U.S. dollar that may have peaked and a swollen valuation gap even as technical indicators and fundamentals abroad firm. For them, it isn’t a question of when, but rather how -- will the U.S. slump back to the pack, or will the erstwhile also-rans lap the leader?
“For now, I’m dating this rally as opposed to marrying it,” said Michael Purves, the chief global strategist at Weeden & Co., who recommends buying bullish options in developing-nation stocks. “The downward momentum in emerging-market equities had been fading amid the backdrop of escalating trade tensions -- to me, that is a huge technical tell.”
Not everyone has gotten the message yet. Fund managers surveyed by Bank of America seemingly went all-in on the divergence trade in September, making bets that the S&P 500 Index will extend its nearly 15 percentage point year-to-date outperformance over global peers.
But skeptics say the recently-mighty dollar has lost its momentum, with rising nominal and real Treasury yields failing to spark gains. A JPMorgan index of emerging-market currencies is on track for one of its biggest weekly gains this year as volatility in developing nations abates.
Ken Veksler, the director of London-based Accumen Management Ltd., says evidence of the coming divergence can be seen in leveraged investors pulling back on their dollar optimism, profit taking as the third quarter ends and emerging-market assets moving more in line with each other.
Green shoots across emerging markets have fostered optimism this week. Notably, China reiterated its pledge to avoid using currency devaluation as a trade-war tactic.
A peaking dollar and political progress has BlackRock touting opportunities in emerging-market as well as Italian debt. Positive news has helped investors refocus on the convergence in economic fundamentals, which shows a recoupling in activity relative to expectations. UBS’s short-term investment opportunities team also just shifted to neutral from positive on the greenback, citing “a recovery in business sentiment (and growth) in key partners.”
Mind the Gap
The decoupling between U.S. and emerging-market equities has been less about the relative recent corporate performance and more about a divergence that’s expected to persist.
That is, the ratio of the trailing earnings per share metric in the U.S. compared with developing-market stocks has increased by far less than forward profit expectations.
“Emerging markets’ realized earnings this year have managed to hang in there with the S&P 500’s, which was driven by one-time tax benefits,” said Mayank Seksaria, the chief macro strategist at Macro Risk Advisors.
The “big expansion of the forward valuation gap” is cause to expect emerging-market equity outperformance should their currencies stabilize, he added.
Fixed-income specialists are singing a similar tune.
“U.S. exposure has been outstanding and now is one of those times, it’s really a once in a few years opportunity, to own EM assets,” said Henry Peabody, a portfolio manager at Eaton Vance, who owns U.S. dollar-denominated Argentine debt. “You can buy local-denominated EM close to domestic high-yield spreads, you can buy dollar-denominated EM at a slight give with a dramatic improvement in balance sheet quality.”
The largest exchange-traded fund holding emerging-market local currency debt also enjoyed its biggest inflow in more than a year on Tuesday.
Two Kinds of Convergence
The glass half-full recoupling between the U.S. and rest of the world would entail an emerging-markets rebound amid positive spillovers from Chinese fiscal stimulus. Beijing has “tons of room to move” after a period of belt-tightening, noted Bank of America Merrill Lynch investment strategist Jared Woodard, saying there’s great risk-reward dynamics in the nation’s equities.
But that’s not the bank’s base case.
“The bearish scenario, which is maybe a little bit more plausible, is that wage inflation in the U.S. keeps the Fed hawkish, tighter credit conditions start to squeeze some of the extremely overleveraged corporate sector,” he added.
JPMorgan strategists led by Marko Kolanovic recently cut their outlook on U.S. stocks, saying the “sugar high” from the tax cut would soon fade.
“The time for the rotation may be now,” they concluded.
©2018 Bloomberg L.P.