The latest flash US January PMIs showed that the economy is still in contracting in the new year, with the composite PMI coming in at 46.6 (vs. 46.4 consensus), marking its seventh consecutive month beneath the 50 level that separates expansion from contraction. On the other hand, the Eurozone flash composite PMI yesterday surprised to the upside to move into expansion territory for the first time since June, coming in at 50.2 (vs. 49.8 consensus). The data adds to evidence that the European economy has fared better in recent months.
But this divergence in data means that while the world’s largest economy continues to slow, faster progress in other regions toward a growth inflection point is creating opportunities in select parts of global financial markets.
The improving economic outlook in China and the Eurozone supports emerging market and German equities, in our view. We expect China’s reopening to be positive for export demand, and over the course of the year, we anticipate a weaker US dollar, which tends to help emerging market stocks. Earnings momentum and earnings estimate revisions are bottoming relative to developed market peers. The MSCI Emerging Markets Index still trades at a 40% discount to the MSCI World (at a 12-month forward price-to-book ratio of 1.5x, versus 2.5x), a level historically consistent with positive performance in the next 12 months.
Europe is expected to benefit from lower gas prices. We expect this to be particularly supportive of the European consumer, and as such, we like European consumer stocks. We also continue to like German equities, which should benefit both from improving growth in Europe and from China’s reopening, given the German market’s export-oriented composition. By contrast, we retain a least preferred stance on US equities and the technology sector.
An inflection point in global growth should bolster demand for commodities, especially oil and industrial metals. China’s faster reopening should benefit energy and industrial metals. The lack of adequate supply growth and even outright production cuts also favor higher prices in energy, industrial metals, and parts of agriculture. Expected returns in commodities benefit from attractive carry; downward-sloping futures curves offer roll gains, while higher yields have improved returns on cash collateral.
In currency markets, recent economic trends also support the Australian dollar. We expect the Aussie to be supported by China’s reopening, Australia’s relatively strong economic growth, and a central bank that is likely to keep the reins tight when the Fed starts to ease monetary condition. Indeed, AUDUSD jumped to a five-month high of 0.7085 today after the latest consumer price inflation data hit its strongest level in 33 years, reigniting speculation that the Reserve Bank of Australia will continue to tighten policy at its next meeting.
So, we like strategies that provide exposure to equity market upside while adding downside protection. We think selectivity will be rewarded, and our positioning reflects that. We incorporate a combination of defensive, value, and income opportunities that should outperform in a high-inflation, slowing-growth environment, alongside select cyclicals that should perform well as and when markets start to anticipate the inflections.
Main contributors - Mark Haefele, Vincent Heaney, Patricia Lui, Christopher Swann
Content is a product of the Chief Investment Office (CIO).
Original report - Growth divergence underscores select investment opportunities, 25 January 2023.