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Investment outlook

Where do global equity markets go from here?

David A. Chalupnik

Head of U.S. Active Equities Portfolio Management

Co-Head of Santa Barbara Asset Management

Thomas (Tom) Franks
CIO, Head of Global Active Equities Portfolio Management
Rocks smashing onto other rocks

After a dramatic collapse in the fourth quarter of 2018, most global equity markets recouped a good portion of their losses in the first quarter of 2019. We believe the magnitude of the previous quarter’s decline was disproportionate to any deterioration in fundamentals for both the global economy and company profits.

Key takeaways
  • Within U.S. sectors, information technology performed best for the quarter, followed by real estate and industrials. Health care, financials and materials lagged.
  • The next move for markets will be determined by whether the global economy proves resilient or falters.
  • Despite a less promising profit outlook, we think moderate inflation and accommodative monetary policy provide room for equities to move higher.


Resilience of global economy will likely determine path

In our view, the next move for markets will be determined by whether the global economy proves resilient or falters. We expect global growth will persist, as the recent dovish shifts by the U.S. Federal Reserve (Fed) and other central banks provide monetary stimulus, a positive for growth. In other words, the sharp drop in government bond yields and lowered interest rate expectations in the past six months portend a pickup in global activity. This outlook puts us at odds with pessimists who see the policy and yield shifts as an indication of worsening economic conditions and too late to prevent a recession.

We think capital markets have reached a fork in the road: Equities and bonds will either advance further or falter significantly. The challenge is that it could take some time to decisively determine which path investors will take amid a mixed backdrop of heightened economic uncertainty and ongoing accommodative monetary policy. Most likely, volatility will persist as markets wait for economic data to confirm either resilience or a continuation of the slowdown that has occurred over the past year.

U.S.: Equities can still rise modestly over the next year

Despite the yield curve’s flattening and late-March inversion, we don’t believe a recession is imminent. Consumer fundamentals are healthy, though we acknowledge that consumer sentiment—which we monitor closely—has weakened slightly, reflecting concern that trade issues will worsen. Nonetheless, measures of consumer optimism remain at historically elevated levels.

In addition, robust wage growth and hiring should allow personal consumption to stay solid, supported by the Fed and lower bond yields. In contrast, a global slowdown and U.S. trade policy are still potential headwinds. Either or both could derail the U.S. economy by undermining hiring and investment.

The equity market is always a good place to begin looking for signals on the state of the economic cycle. In the first three months of the year, the S&P 500 Index retraced its fourth quarter plunge, as the Fed paused its cycle of interest rate hikes and the odds that the U.S. and China would reach a short-term trade truce appeared to brighten. A consensus view has not been reached on the pace of global economic growth, which continues to decelerate. One key to the direction of financial markets and the U.S. economy will be the extent to which China’s stimulus measures help its economy.

We expect U.S. stocks to rise modestly over the next year, a view predicated on several scenarios that could lead to different outcomes. A significant rise in equities would likely require economic expansion to last through late 2020, the Fed to stop raising interest rates, the U.S. and China to reach a trade agreement and the Chinese economy to accelerate.

We conclude that the global economy should continue to expand fast enough to support stocks in the short term. However, gains may be harder to come by in the intermediate term.



The global economy should expand fast enough to support stocks in the short term. Gains may be harder to come by in the intermediate term.

Europe: The economy is a very mixed picture

The eurozone’s downturn has been driven largely by external factors ranging from Brexit to trade tensions to a slowing China. If China’s growth rate has indeed bottomed, the country’s export outlook can improve again. However, it will likely take a few months until European businesses start to notice the impact that easing trade tensions and China’s stimulus measures may have on domestic demand.

Manufacturers are currently feeling the pain. In March, the European Commission’s industry confidence survey for the European Union (EU) saw export orders fall to their lowest level since the fall of 2016. Additionally, the decline in the eurozone’s manufacturing Purchasing Managers’ Index (PMI), from 49.3 in February to a nearly six year low of 47.5 in March, shows that the region’s industrial recession has deepened. (PMI readings below 50 indicate contraction.) New orders, a leading indicator, declined at their fastest rate since late 2012.

Fortunately, not all news out of Europe has been bad. As consumption, government spending and construction have propped up demand, the further contraction of manufacturing activity has not yet spread to the overall economy. Indeed, recent data highlights a domestic economy that is holding up well. Even export powerhouse Germany, which is more exposed to the ongoing trade disputes than most other European countries, saw employment continue to rise in early 2019, with a 2.0% year-over-year gain in core employment in January.

And though consumers may be worried about global risks, they’re still spending. Retail sales in January and February increased 1.7% over their fourth quarter average. Moreover, in March, the European Central Bank (ECB) announced a delay in rate hikes until at least 2020 and fresh stimulus in the form of very low interest rate loans to eurozone banks. By pinning down eurozone bond yields, the ECB is also anchoring global rates.

We believe European economic growth will recover, based on the resilience of domestic demand, our outlook for better economic data out of China, an easing of trade conflicts and, hopefully, a constructive resolution of the Brexit drama. In our view, Europe’s return to a healthy state of economic growth has merely been delayed, not derailed.

U.K.: The Brexit saga continues

After the U.K. Parliament rejected Prime Minister Theresa May’s EU withdrawal agreement on 29 March, the remaining 27 EU members began to lose their patience. On 11 April, however, the U.K. and the EU agreed to a 31 October “flexible extension” deadline, allowing negotiations to continue. The situation remains fluid.

What might happen next?
  • "Hard” Brexit, or a complete separation from the EU: (Unlikely) A majority of members of Parliament (MPs) want to retain close ties with the EU. Consequently, they are staunchly against such an outcome.
  • Long delay that eventually ends in a soft Brexit: (Moderate-to-high chance) In this scenario, lacking a majority of MPs in favour of a softer Brexit outcome prior to the U.K.’s departure, Parliament asks for and receives a long extension from the EU. Then, through the continued process of cross-party negotiation, Parliament ultimately endorses a soft option that the government adopts as its plan for negotiating the future relationship.
  • “Snap” election and/or second referendum: (Tail risk/very unlikely) If Parliament cannot amass majority support from MPs for a softer Brexit, it may resort to backing a second referendum, thereby shifting the responsibility of deciding Brexit back to the voters.

China: Signs of hope emerge

Is Beijing’s stimulus finally working? The answer is probably yes, although it’s still too early to tell. China’s Caixin Manufacturing PMI rose from 49.9 in February to 50.8 in March, its best reading since last July. Thanks to a string of simulative measures implemented in the second half of 2018 (including cuts in minimum reserve requirements for banks and increased borrowing limits for local governments), this rebound reached the real economy with the usual lag time. That said, the March improvement should be interpreted with caution. The timing of the Lunar New Year holidays probably weighed on the PMI in February, leading to a bounce back the following month. Nonetheless, with other data showing less sluggish credit growth, the uptick in the index supports the view that China’s slowdown may well end soon.

Additional fiscal measures also point in the right direction, including tax cuts worth more than 2% of GDP, enacted in early March. Upbeat comments on the U.S./China trade talks from U.S. trade representative Robert Lighthizer—and even President Trump—are a positive as well.


Japan: The economy remains sound, thanks to consumers

Last year, Japanese equities were hurt by a slowing global economy, which drove down company earnings growth from 30% in 2017 to 4% in 2018. Economic activity rebounded in the fourth quarter of 2018, following disruptions caused by extreme weather and natural disasters in the third quarter.

Even with declining external demand, the Japanese economy remains sound, sustained by domestic consumption and supported by construction related to the 2020 Tokyo Summer Olympics. Businesses continued to invest in automation in response to labor shortages. Consumption is likely to be especially strong in the early part of 2019, given the planned consumption tax increase in October 2019. Immigration reform should also aid the economy by easing the chronic shortage of labor stemming from an aging population.

On the monetary policy front, the Bank of Japan (BoJ) is, as always, dedicated to increasing the stubbornly low rate of inflation. We expect the BoJ to keep monetary policy steady and accommodative; the weaker global backdrop gives the central bank little opportunity to withdraw monetary stimulus. In terms of trade, Japan has continued to try to persuade the U.S. to avoid raising tariffs on autos. It’s likely that Japan will lower tariffs on U.S. beef in an effort to reduce its $69 billion trade surplus with the U.S.

Asia: China remains key

Asian equities rallied at the very end of 2018 and into early 2019 to retrace some of their fourth-quarter losses. Investors began to consider the possibility that the Fed will raise interest rates no more than once in 2019. However, optimism created by prospects for lower rates and declining trade tensions have been tempered by concerns that Asian economies will continue to decelerate.

We expect a slowdown in Asia over the first half of the year, amid soft global demand and a drop in exports after tariff fears accelerated orders. That said, a recovery is likely in the second half of 2019, driven by further monetary stimulus in China, an accommodative Fed and a slightly weaker U.S. dollar. In our view, a second half uptick would benefit more open economies such as Hong Kong, South Korea, Taiwan and China. Overall, China remains the linchpin due to the size of both its economy and its equity market.

Emerging markets: Not looking to repeat 2018

We are optimistic about emerging market (EM) equities and do not believe that 2018’s performance pattern—when markets peaked at the end of January and collapsed for much of the rest of the year—will be repeated in 2019. A global backdrop characterized by a dovish Fed and ECB, joined by fiscal stimulus and accommodative monetary policy from China, has usually been associated with EM out-performance.

Indeed, over the next few quarters, we expect an end to the U.S./China trade standoff, gradual improvements in trade data and signs of stabilization in global growth. This supportive environment should benefit the EM sphere broadly and those markets with the largest exposure to trade in particular—namely China, Korea and Taiwan.

In terms of the first quarter’s EM equity results, some of the recovery has already been reflected in relative returns. Further upside for Korean and Taiwanese stocks will likely require a meaningful turnaround in semiconductor sales, which we are confident can occur this year.

Last year’s decline in EM equities brought their average price-to-earnings (P/E) ratio down from 16x earnings to 12x earnings. Overall, valuations remain very attractive even after 2019’s strong year-to-date performance. EM stocks also offer better value on a price-to-book basis than they did a year ago, thanks to a recovery in returns on equity.


Equities can still rise from here

The powerful stock market rebound in the first quarter of 2019 began from a point of extreme pessimism and substantially reduced valuations. Recent pivots by central banks, together with encouraging progress on the U.S./China trade front, have reversed fortunes dramatically. Thus, even with the strong gains already achieved year to date, we believe the rally can persist as long as corporate earnings meet investor expectations.

We recognize that the profit outlook for 2019 is less rosy than last year’s, given slower global economic growth and the absence of another round of U.S. tax cuts. Even so, against a backdrop of moderate inflation and accommodative monetary policy, there continues to be room for equities to move higher.

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Index Performance: FactSet European Corporate Earnings: I/B/E/S 
U.S. Corporate Earnings: Standard & Poor’s
Employment: RBC Global Asset Management 
Russell Indices: FactSet, Russell Investments 


Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI ACWI-All Country World (ex U.S.) Index is a market capitalization weighted index designed to provide a broad measure of global equity market performance excluding the U.S. MSCI EAFE Index is a free Float adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Russell 1000® Index is an index of approximately 1,000 of the largest companies in the U.S. equity markets. Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher expected growth values. Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Russell 2000® Index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Russell 2000® Growth Index measures the performance of the large-cap growth segment of the Russell 2000 Index. Russell 2000® Value Index measures the performance of the large-cap value segment of the Russell 2000 Index. Russell Midcap Index is a market capitalization weighted index comprised of 800 publicly traded U.S. companies with market caps of between $2 and $10 billion. Russell Midcap Growth Index measures the performance of the large-cap growth segment of the Russell Midcap Index. Russell Midcap Value Index measures the performance of the large-cap value segment of the Russell Midcap Index. Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. S&P 500® Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.

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A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.

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