CIO global strategy seeks to take risk chiefly through high grade, investment grade, and emerging market debt. (ddp)

We therefore see an unusually large opportunity set among equity laggards at this time. For global investors, the most relevant, in our view, are emerging market equities, equal-weighted US stock indexes, value stocks, and defensive sectors.

But investors wanting to look further afield—especially those with particular region, sector, or thematic interests—may also find value in a number of other areas:

Geographically, we see compelling laggards in the US, Europe, and Asia

US energy stocks (S&P 500 Energy Index) have lagged the S&P 500 by around 25 percentage points this year despite solid earnings prospects and appealing valuations, and their forward free cash flow yield of 11% looks especially attractive to us. The sector could also be a cheap hedge for an unexpected increase in inflation, in our view.

In Europe, German equities have lagged Eurozone stocks' performance by 1.5 percentage points so far this year despite their tilt toward high-quality, internationally diversified companies, which may look appealing during a more uncertain second half of the year. German equities still trade at a 20% relative price-to-book discount to Eurozone ex-German equities, and investor sentiment is depressed despite an increase in relative three-month average earnings revisions. We also see attractive value in small and mid-size companies (MSCI EMU SMID Index) and expect them to close a 7-percentage-point underperformance versus large caps (MSCI EMU Index). We also like select diversified European and Swiss stocks that have lagged the broader market—mostly for idiosyncratic reasons—but have solid fundamentals and attractive earnings growth prospects.

In Asia, we see scope for markets like India, Indonesia, and the Philippines to close their performance gap with North Asia and extend the 220-basis-point outperformance over South Korea and Taiwan seen over the past month.

Investors may also find opportunities in Japan, though in laggards such as quality value names, including banks, and domestically oriented sectors like consumer discretionary and service sectors to capture potential structural changes. In China, we see opportunities in the internet sector following its near 25% fall from January’s peak. While rising growth concerns have weighed on the sector’s performance, we think the market has neglected its low- to mid-teen earnings growth potential over the medium term, as seen in forward P/E ratios that are nearly two standard deviations below the five-year average.

Tech-focused investors can find value in cybersecurity

For investors looking at thematic opportunities, we see scope for cybersecurity names to do well in the second half.

Cybersecurity-related stocks (HACK ETF) are up by mid-teen percentage rates this year, lagging AI-related stocks (the "A" in our "ABCs of tech" theme) by roughly 25%. The mainstream introduction of AI tools highlights the importance of cybersecurity in protecting data. Other factors that support the theme include urbanization, stricter regulation, and heightened consumer awareness of product quality, environmental protection, and social responsibility. We estimate the addressable security and safety market overall will grow from USD 809bn this year to USD 861bn next year.

Equity selectivity does not detract from our preference for bonds over stocks

While investors underallocated to equities can find opportunities in laggards, we maintain our general preference for high-quality bonds over equities in the second half.

First, the resilience of the US economy this year is already priced into the S&P 500, in our view, setting the bar higher for the rest of the year. Second, we expect not only inflation to slow in the second half, but also economic growth—potentially close to zero and threatening companies’ ability to increase their earnings. Third, the uncertain scale of the lagged impact of prior interest rate hikes means that both a recession and a Fed policy error remain potential risks.

Our global strategy therefore seeks to take risk (and generate returns) chiefly through high grade, investment grade, and emerging market debt. We also like select currency and commodity exposure, preferring the euro, Japanese yen, oil, and gold.

Main contributors - Solita Marcelli, Mark Haefele, Matthew Carter, Christopher Swann, Jon Gordon

Original report - Equity laggards – Looking further afield, 19 July 2023.