Notes on Global Equity Markets

Transcription

1 Investment Team Update 23 October 2017 Notes on Global Equity Markets PERSPECTIVE FROM THE TEMPLETON GLOBAL EQUITY GROUP Market Overview: Global and international equity markets advanced in the third quarter, continuing the strong rally seen across markets this year, as global economic growth, rising corporate profits and still-easy financial conditions offset rising geopolitical tensions, signs of US government discord and weather disasters. Energy: The price of oil rose during the quarter, as did energy stocks, though to a lesser extent. Investor skepticism remains as to the sustainability of firming oil prices, and the supply restraint required to support that. At the stock level, skepticism surrounds oil producers ability to meet production growth and earnings targets in this environment. Health Care: Health care stocks have bounced back in 2017 after becoming largely oversold during the election cycle rhetoric of A few stock setbacks overshadowed some solid performers in the quarter. Cindy L. Sweeting, CFA President, Templeton Investment Counsel, LLC, Director of Portfolio Management, Templeton Global Equity Group Antonio T. Docal, CFA Executive Vice President, Deputy Director of Research, Portfolio Manager, Research Analyst, Templeton Global Equity Group Peter A. Nori, CFA Executive Vice President, Portfolio Manager, Research Analyst, Templeton Global Equity Group Financials: The European banking sector has continued to make progress. In Asia, prospects for improving corporate governance and political stability have combined with rising interest rates and economic growth to benefit select bank and insurance franchises. Information Technology: Finding value has become a bit challenging, with margins and earnings that appear to be cyclical peaks. We believe that our existing holdings, which include a mix of US hardware and software stocks, along with Asian semiconductors, hardware, and internet shares, continue to offer long-term value. Materials: We have found some opportunities in industrial base metal miners with exposure to copper and zinc and avoided oversupplied areas such as iron ore and coal. We have also found value in precious metals. United States: Unlike Europe, where the risk premium has been high for some time and has room to recede, risk appears underdiscounted in the United States, where valuations may inadequately reflect rising political uncertainty, tightening monetary policy and a more mature profit cycle. Europe: The eurozone is now showing the strongest manufacturing activity relative to all other major economic blocs. Corporate earnings are recovering, the banking sector is functioning again, political headwinds have been more benign than anticipated and the macro backdrop is improving. Emerging Markets: Emerging economies are beneficiaries of globally synchronized growth. Excesses should be noted on the debt side and selectivity is warranted. Japan: A fairly broad opportunity set has materialized in Japan. We ve found stock ideas in a variety of sectors, including industrials, electronics, retail, real estate, beverages, telecom, oil and gas exploration, autos, tires, factory automation and materials. And with the corporate sector generating positive cash flow, we believe companies have plenty of room to further boost investment and boost dividend payouts.

2 Market Overview Global and international equity markets advanced solidly in the third quarter, continuing the strong rally we ve seen across most markets this year. Investors have largely shaken off rising geopolitical tensions, ongoing signs of US government discord and dysfunction and a string of weather disasters to focus on some clear positives. These include improving and now highly synchronized global economic growth, rising corporate profits and cash flows and still-easy financial conditions as the developed world central banks continue to bide their time in moving forward with monetary policy normalization. The biggest economic change over the past year has probably been the surging eurozone economic recovery. The other notable region of relative strength this quarter, and year, has been China, which has shown ongoing resiliency in the lead up to its 19th Party Congress later this month. Solid economic growth has let China selectively tighten credit, stem the outflow of foreign reserves that spooked the market last year, and to also cut some industrial overcapacity without any major fallout. Energy Several factors drove oil prices back to the $50+ level per barrel during the quarter, including declining oil inventories, potential disruption of the Kurdish oil pipeline deliveries, the crisis in Venezuela and importantly, global demand, which was revised upward several times this year. Going forward, oil prices could be range-bound in a mid-cycle type of environment between $50 $60/barrel where OPEC (Organization of the Petroleum Exporting Countries) action on the one hand limits price declines, and US shale, a highly elastic swing producer, caps the medium-term upside. With sustained oil prices in this range, we believe our holdings offer upside as they still largely reflect sub-$50 oil. Said differently, oil prices are up more than 30% since June, but global energy stocks are up less than 10% since then, meaning there could be substantial catch-up potential in our energy holdings. Health Care We are investing where our analysis suggests that the long-term free cash flow and earnings-per-share power is underappreciated by the market. Despite a rebound last year, pharmaceuticals stocks still trade at a rare discount to the global stock market on forward earnings. Rising controversy in the pharmaceuticals industry is reflected in valuations. Concerns about patent expiries, pricing power and health care reform in the United States have taken the luster off health care stocks. Yet, nearly half the revenues at risk from upcoming patent expirations come from biosimilars, where erosion rates are likely to be much slower. As to pricing power, the industry has faced increasing pressures for some time as payers continue to consolidate. Innovation and differentiated products will be required. Even if the Trump administration passes health care reform, any measures would likely be consistent with the traditional Republican idea of market-based pricing. We continue to find attractive long-term value in lowly valued pharmaceuticals companies with innovative pipelines and novel drug franchises capable of dealing with pricing and competitive issues on a case-by-case basis. Financials We continue to find bottom-up opportunities in the sector and maintain exposure to financial holdings in a number of the major regions including the United States, Europe, the United Kingdom and Asia, but we notably have limited-to-no exposure to banks or other financials in Japan, Australia or Canada. In the United States, we have been attracted to opportunities offering a good combination of solid tangible book value growth, rising dividend yields, and a somewhat less onerous regulatory environment. The European banking sector has continued to make good progress. Earnings revisions have returned to a positive trajectory, regulatory capital has been largely rebuilt and the bulk of post-crisis regulation efforts now appears to be complete. While European banks still look undervalued relative to their own history at their current returns on equity and versus US banks, value opportunities are now becoming more selective. In Asia, prospects for improving corporate governance and political stability have combined with rising interest rates and genuine economic growth to benefit the regional banking sector over the last year. We believe South Korea, in particular, is a good example of a banking market subject to positive cyclical and structural tailwinds that still trades at undemanding valuations, despite its very strong rally from notably distressed levels over the last year. Materials The China-driven commodity bubble burst in 2011, and in late 2015, we saw the capitulation phase of the bear market, with many metals trading below their cash-cost curves. Then China came out with a new round of stimulus in early We found some opportunities in industrial base metal miners with exposure to copper and zinc and avoided oversupplied areas such as iron ore and coal. With growth in China, the sector ran hard and went from depressed margins to peak margins a full cycle in less than a year. We used this strength to take profits in some holdings and, more recently, found select opportunities in precious metals. Information Technology Earnings and free cash flow have been strong this year, and we have also seen companies return an increasing amount of cash in the form of buybacks and dividends. Investors now seem willing to look further into the future with a higher degree of confidence at themes that include cloud computing, big data, artificial intelligence, electric vehicles, autonomous vehicles, the internet and security, all of which involve increased use of technology. We think this has helped expand valuations across the sector. Finding value has become a bit challenging, with margins and earnings that appear to be at cyclical peaks. We Notes on Global Equity Markets 2

3 believe our existing holdings, which include a mix of US hardware and software stocks, along with Asian semiconductors, hardware and internet shares, continue to offer long-term value. Emerging Markets Our exposure to these markets has risen over the past several years, but our positioning within emerging markets has been primarily focused on stock opportunities in north Asian markets like China, South Korea and Taiwan. Emerging markets, despite their often higher economic growth rates, have historically traded at discounts to the developed world and usually a deserved discount due to higher risk levels, including currency foreign debt exposure, corporate governance, financial accounting shenanigans and fairly limited transparency. So we really focus on stock-level fundamentals and outlooks and continue to be wary of unsustainable earnings trends or poor balance sheets and potential pressures on profitability and on currency over the longer term. In our view, the greatest risk would be related to either a notable slowdown in China s economy or an unexpectedly hawkish term from the US Federal Reserve. China is probably the one market where a significant slowdown in growth could see contagion across emerging markets. China We favor consumer-focused companies in China that trade at attractive valuations, particularly in the telecom, health care and insurance sectors. We have avoided expensive stocks and those that we believe have excessive systemic risks, like banks, or excess leverage, like property and infrastructure. South Korea We think many of the risks typically associated with South Korea are overstated and that many are receding. South Korea remains a dynamic economy, with strong global positions across technology consumer products, automotive and shipbuilding industries. Recent moves in some companies to increase shareholder returns have been positive and well-received. Additionally, regulatory relief from the financial sector has allowed some banks to deploy capital, reduce costs and improve the return of equity, which has led to an improvement in price-to-book value. Japan A fairly broad opportunity set has materialized in Japan. We ve found stock ideas in a variety of sectors, including industrials, electronics, retail, real estate, beverages, telecom, oil and gas exploration, autos, tires, factory automation and materials. Progress has undeniably been slow, but there are signs that Japan may be finally emerging from its long period of economic stagnation. Japanese gross domestic product (GDP) delivered its sixth consecutive quarter of expansion in the second quarter of this year, which has been the longest sustained bout of growth since before the financial crisis. And encouragingly, corporate profits are currently rising faster than GDP, assisted as they are by an undervalued yen. And with the corporate sector generating positive cash flow, we believe companies have plenty of room to further boost investment and potentially boost dividend payouts. Europe The eurozone just delivered its best GDP growth in five years, growing faster than the United States. Other signs are very bullish, including the purchasing managers index, consumer sentiment and bank credit growth. On the political front, we re significantly better off than we were a year ago, when extreme right and left parties had sizable showings in the polls. Recent actions supporting Catalonian independence represent a current headline risk and a reminder that Europe s economic recovery isn t necessarily synonymous with political tranquility. Europe is trading near the lowest cyclically adjusted P/E ratio relative to the United States on record. Both the equity market rally and the economic recovery in Europe remain less mature than in the United States, and we believe it has much more room to run. United States Corporate margins and earnings per share are well above the levels reached in the 2007 cyclical peak. Unlike Europe, where the risk premium has been high for some time and has room to recede, risk appears under-discounted in the United States, where valuations may inadequately reflect rising political uncertainty, tightening monetary policy and a more mature profit cycle. We ve been finding value in the financials, technology and health care sectors. Notes on Global Equity Markets 3

4 Outlook Our Templeton culture is to continuously work to stay objective and to note where investors might be in the often-repeated psychology cycle that Sir John Templeton coined: Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. Should this elongated economic cycle, which now appears to be running pretty smoothly on all cylinders, start to show some typical end-of-cycle signs, such as slowing earnings momentum or inverted yield curves, we will work to notice these changes in business trends and outlook at the company level. Our balance sheet work remains as important as our assessment of forward earnings. At the current time, however, we don t see any real signs of genuine euphoria and recognize still enough evidence of mispriced equities around the world to find solid opportunities. With global central bankers now leaning toward incremental tightening, equity markets would probably welcome some evidence of caution and sentiment and valuation levels as well as a more normal interest-rate structure that could support and extend this bullrun. At this time, we don t believe central bank policy tightening will be severe enough to cause a downturn. But, in our assessment, the swing factors for the market going into 2018 will certainly be interest rates, inflation indicators and economic growth and earnings prospects. And we will, as always, strive to stay disciplined, objective and opportunistic in our bottom-up analysis at the company and sector levels. WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. Notes on Global Equity Markets 4

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