2018 Mid-Year Global Market Outlook Weatherproof Your Portfolio Global Equities US Stimulus Extends Equities Runway Even as US large-caps benefit from increased capital expenditure, the time is right to be more defensive. Gaurav Mallik Chief Portfolio Strategist 2018 Mid-Year Global Market Outlook 1
Equities Overview US Surprises to the Upside Heading in to 2018, we anticipated an equity market correction sometime during the year, as valuations in certain sectors looked extended, and that is exactly what we saw in Q1. Our big question for the US equity market was how much of the fiscal stimulus had already been priced into stocks or whether the potential of increased capital investments could extend the nine-year US bull market even further. Investors finally began to reward US companies toward the end of the first half for one of the strongest earnings seasons on record, with 24% year-on-year growth. Meanwhile, the immediate expensing provision of the new tax rules has dramatically boosted capital expenditure, especially at US tech companies, driving productivity growth higher. In Q1 alone, capex spending by S&P 500 companies was estimated to have risen by 24%, the highest year-over-year growth in seven years. 1 While there is some evidence that shares in companies that invest heavily in capex tend to underperform the broader stock market, higher spending could alleviate worries that profit growth at S&P 500 companies might have peaked. With concerns growing about a lack of workers as the economy marks decadeslow levels of unemployment, investments in automation could help companies bridge those labor gaps and lengthen what is already a very long business cycle. In other developed markets, Europe and Japan have struggled to repeat the stellar performance of 2017, as sentiment data softened in the first half. Following a year in which its stock market was one of the best performing in the world, Japan s Topix was down by 8% in the first quarter in dollar terms and by 2% in yen terms. As we discuss in our macroeconomic outlook for the second half, Japan seems to have reached its growth peak, mainly due to its severe shortage of workers. Still, our investment team continues to find attractive companies to invest in, as the Bank of Japan keeps monetary policy loose and company earnings reach all-time highs. Figure 1 Change from Previous Year in CapEx among S&P 500 Firms 30 % 20 10 23.6% 0 10 20-30 Q4 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Q1 2018 Sources: Wall Street Journal, Credit Suisse as of May 15, 2018. Data for the first quarter of 2018 is based on preliminary Credit Suisse estimates. Heading into the second half, European stocks found new sources of strength after a weak start to the year, as earnings improved, the euro declined and the US showed signs of calibrating its trade policy with China more carefully. 2018 Mid-Year Global Market Outlook 2
That announcement was good news for China and emerging markets in general, whose stock markets have been buffeted by higher currency volatility and rising oil prices. Higher oil prices are good news for oil exporters but less so for emerging countries whose economies are more energy-intensive than developed markets. We remain constructive on emerging market equities, especially China, though we are closely watching political events in potential hotspots like Turkey, Venezuela, Argentina and Brazil. Figure 2 shows relative valuation across global equity markets as of the end of May. 1 Capital Investment Soars at Firms, Wall Street Journal, May 16, 2018. Figure 2 Relative Value Across Global Equity Markets: US Still Has the Edge 4.0 3.5 3.0 Price to Book Ratio (P/B) 3.45 3.27 2.96 Current 15 Year High 15 Year Avg. 15 Year Low 2.5 2.0 1.5 1.0 2.59 1.64 2.59 2.44 2.08 1.16 2.42 1.73 1.60 1.05 1.77 1.63 1.16 2.14 1.41 1.36 0.90 2.20 1.59 1.57 0.96 0.5 S&P 500 Index Russell 2000 Index MSCI EAFE Index MSCI Emerging Markets Index MSCI Japan Index Euro Stoxx 50 Index Sources: Bloomberg Finance, L.P.,. As of May 31, 2018. Characteristics are as of the date indicated and should not be relied upon as current thereafter. Sectors Significant Rotation as Rates Rise Figure 3 shows the equity sectors most exposed to rate risk such as real estate and utilities with negative correlations, while financials and energy correlate more positively. The correlation dispersion between utilities and financials has ratcheted up considerably in the last few months. This can be problematic for highly defensive portfolios, which often contain bond proxies such as utilities. Figure 3 Correlation for Utilities and Financials Problematic for Defensive Portfolios 0.8 0.6 0.4 0.2 Correlation 0.0 Maximum -0.2 Median -0.4 Minimum -0.6-0.8-1.0 Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Real Estate Telecommunication Services Utilities Sources:, MSCI, FactSet as of February 28, 2018. USD. Averaged over prior five years. Correlation measures the degree to which two variables are related. Correlation coefficients range from -1.0 to 1.0. A coefficient of -1.0 indicates perfect negative correlation between two variables, while a coefficient of 1.0 indicates perfect positive correlation. A coefficient of 0 indicates there is no relationship. 2018 Mid-Year Global Market Outlook 3
Healthcare and financials remain our two most favored sectors for 2018, though we recognize that cyclical sectors like energy and industrials now face favorable tailwinds for the second half as oil prices move higher (Figure 4). Within the tech sector we prefer lesscrowded innovators. Figure 4 Rising Oil Prices Creating Opportunity for Energy and Industrials S&P 500 Energy Sector Relative to S&P 500 Index (lhs) WTI Crude (rhs) 0.27 0.26 0.25 0.24 0.23 0.22 0.21 0.20 Relative Performance USD/barrel 80 70 60 50 40 0.19 0.18 30 0.17 Jan 2016 Apr Jul Oct Jan 2017 Apr Jul Oct Jan 2018 Apr 20 Source: Macrobond as of May 21, 2018. Factor Performance Tech Driving Value Preponderance in Large-Cap Indexes Because large-cap benchmarks are so disproportionately skewed by tech names, the extremities of factor performance across growth, value and sentiment (or momentum) manifest themselves dramatically in those large-cap indexes. Apart from less exposure to potential trade disputes, small-cap and mid-cap names are less affected by factor skewness. For example, value has diverged much more severely in large-caps than in smallcaps, as well as between emerging and developed markets. Investment Implications Not Quite There Yet While we will not hazard to call the top of the equity markets, we know we are closer to the end of this cycle than to the beginning. That is what drives us to be more cautious and take some risk off the table. While we still maintain an overweight to US large caps, we are underweight to Europe and retain a small overweight to both Japan and emerging market equities. With the increased capital expenditure in the US, we see the potential for lengthening the runway for US stocks. But there are enough uncertainties still around geopolitics, trade protectionism and inflation risk for us to adopt a more defensive approach and deploy our teams stock-picking skills to identify attractive, late-cycle opportunities. 2018 Mid-Year Global Market Outlook 4
Glossary CapEx Capital Expenditure Large-Cap A company with a market capitalization of over $10 billion. Mid-Cap A company with a market capitalization between $2 billion and $10 billion. Small-Cap A company with a market capitalization of less than $2 billion. 2018 Mid-Year Global Market Outlook 5
ssga.com State Street Global Advisors Worldwide Entities Australia, Australia, Limited (ABN 42 003 914 225) is the holder of an Australian Financial Services Licence (AFSL Number 238276). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia. T: +612 9240-7600 Belgium Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: 32 2 663 2036, SSGA Belgium is a branch office of Limited. Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Canada, Ltd., 770 Sherbrooke Street West, Suite 1200 Montreal, Quebec, H3A 1G1, T: +514 282 2400 and 30 Adelaide Street East Suite 500, Toronto, Ontario M5C 3G6. T: +647 775 5900 Dubai State Street Bank and Trust Company (Representative Office), Boulevard Plaza 1, 17th Floor, Office 1703 Near Dubai Mall & Burj Khalifa, P.O Box 26838, Dubai, United Arab Emirates. T: +971 (0)4-4372800 France Ireland Limited, Paris branch is a branch of Ireland Limited, registered in Ireland with company number 145221, authorised and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson s Quay, Dublin 2. Ireland Limited, Paris Branch, is registered in France with company number RCS Nanterre 832 734 602 and whose office is at Immeuble Défense Plaza, 23-25 rue Delarivière-Lefoullon, 92064 Paris La Défense Cedex, France. T: (+33) 1 44 45 40 00 Germany GmbH, Brienner Strasse 59, D-80333 Munich. Authorised and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht ( BaFin ). Registered with the Register of Commerce Munich HRB 121381. T: +49 (0)89-55878-400 Hong Kong Asia Limited, 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. T: +852 2103-0288 Japan (Japan) Co., Ltd., Toranomon Hills Mori Tower 25F 1-23-1 Toranomon, Minato-ku, Tokyo 105-6325 Japan, T: +81-3-4530-7380 Financial Instruments Business Operator, Kanto Local Financial Bureau (Kinsho #345), Membership: Japan Investment Advisers Association, The Investment Trust Association, Japan, Japan Securities Dealers' Association. Ireland Ireland Limited is regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson s Quay, Dublin 2. Registered number 145221. T: +353 (0)1 776 3000 Italy Limited, Milan Branch (Sede Secondaria di Milano) is a branch of State Street Global Advisors Limited, a company registered in the UK, authorised and regulated by the Financial Conduct Authority (FCA), with a capital of GBP 62,350,000, and whose registered office is at 20 Churchill Place, London E14 5HJ. State Street Global Advisors Limited, Milan Branch (Sede Secondaria di Milano), is registered in Italy with company number 06353340968 - R.E.A. 1887090 and VAT number 06353340968 and whose office is at Via dei Bossi, 4-20121 Milano, Italy T: 39 02 32066 100 Netherlands Netherlands, Apollo Building, 7th floor Herikerbergweg 29 1101 CN Amsterdam, Netherlands. T: 31 20 7181701. SSGA Netherlands is a branch office of State Street Global Advisors Limited. State Street Global Advisors Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Singapore Singapore Limited, 168, Robinson Road, #33-01 Capital Tower, Singapore 068912 (Company Reg. No: 200002719D, regulated by the Monetary Authority of Singapore) T: +65 6826-7555 Switzerland AG, Beethovenstr. 19, CH-8027 Zurich. Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ( FINMA ). Registered with the Register of Commerce Zurich CHE- 105.078.458. T: +41 (0)44 245 70 00 United Kingdom Limited. Authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: 020 3395 6000 United States, 1 Iron Street, Boston, MA 02210 T: +617 786 3000 2018 Mid-Year Global Market Outlook 6
Important Information: Disclosure Investing involves risk including the risk of loss of principal. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. This document may contain certain statements deemed to be forward-looking statements. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forwardlooking statements. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent. 2018 State Street Corporation. All Rights Reserved. ID13148-2127436.1.1.GBL.RTL 0618 Exp. Date: 5/31/2019 2018 Mid-Year Global Market Outlook 7