CIO recently upgraded its global equity assessment. Our move, to neutral from least preferred, reflects stronger economic data, better-than-expected moderation in inflation, and healthier corporate earnings than feared.
But investors should not interpret our change in view as a cue to buy stocks indiscriminately. Our more balanced view weighs economic resilience, more solid earnings, and long-term promise from artificial intelligence against challenging valuations.
Global stocks still trade richly. The MSCI All Country World Index trades on 16.1 times forward earnings and an 11% premium rating to its long-term average. Another measure of valuation – the cost of equity – stands at 10-year highs and levels previously associated with investor overconfidence.
We therefore suggest investors seeking to add money to equities consider lagging parts of the market, where valuations are least rich and the potential for a catch-up rally is greatest:
Favor US equal-weighted indexes over market-capitalization-weighted ones. Within US equities, we recommend investors consider switching into equal-weighted indexes where most stocks have catch-up potential.
The 67% year-to-date gain for the NYSE FANG+ index, which tracks the 10 most traded US tech stocks, has had an outsized effect on the traditional S&P 500 Index, up 14.3% this year. This index has a 29% weighting to its largest sector, information technology. By contrast, the S&P 500 Equal Weight Index has climbed 4.1% and has a greater exposure than the cap-weighted index to our most preferred US sectors of consumer staples and industrials.
Investors can also consider shifting to our other most preferred US sectors, like the lagging energy sector, that don’t yet reflect the rebound in oil prices and whose valuations are pricing in a somewhat cautious outlook.
Invest in emerging markets. We have a most preferred view on emerging market (EM) equities and expect them (i.e., MSCI EM Index) to deliver mid- to high-single-digit positive returns this year. Having lagged global equities by around 9 percentage points year-to-date (MSCI EM vs. MSCI AC World, USD terms), we think EM stocks will likely catch up in the months ahead.
The MSCI Emerging Markets Index valuation, at 12x 12-month forward earnings, is largely in line with its 10-year average. But its 37% discount to the S&P 500 Index looks appealing on a relative basis. On a price-to-book basis, the discount is even deeper at 63%, versus its own 10-year average of 54%.
Within emerging markets, we particularly like Indian equities. Supportive macroeconomic factors include falling inflation, a narrowing external deficit, and improving purchasing managers’ indexes. We believe India's market valuation remains reasonable, while the corporate outlook looks healthy.
Favor value versus growth stocks. From a style perspective, we favor an allocation to value versus growth. Over the last 10 years, growth stocks have enjoyed a strong relative performance to value, resulting in extreme valuation gaps versus the overall market and versus value stocks.
Underlying fundamental forces, namely inflation and central bank actions, have changed and are no longer supportive of the growth segment. Historically, periods of high inflation and high yields have been associated with value outperformance, especially during expansions and recoveries. In our analysis, we also noted that when inflation stays above 3%, value tends to perform better than growth, even during recessions.
From a global sector perspective, we favor consumer staples (defensive and resilient earnings at reasonable valuations), energy (a lagging sector set to benefit from improved growth, record high oil demand, and tight oil supply that pushed up prices), and industrials (to benefit from ongoing business investment). We are least preferred on global information technology. Within the tech sector, we think software stocks are best positioned to ride the next wave of the technology cycle and the broadening of AI demand. We would move away from semiconductors and hardware, which have already performed so well so far in 2023.
Investors can also find interesting opportunities in those markets where we hold an overall neutral view. For example, see select opportunities in cheap cyclical corners of the Eurozone market, where we believe a manufacturing recession has already been priced in. Areas of potential interest include European small- and mid-cap equities, materials, autos, and German stocks. We note that autos and chemicals are attractively valued, with price-to-book ratios below the 20th percentile versus their 10-year averages.
In addition, Swiss-focused investors may uncover value in a diversified selection of Swiss stocks that have lagged the broader market—mainly for idiosyncratic reasons, in our view—but that we regard as having solid fundamentals and attractive earnings growth prospects.
Implementation choice may also help investors position well in equities. With some segments of the market sitting on handsome year-to-date gains, investors need to think about how to balance a potentially attractive longer-term outlook with elevated valuations and near-term risks. Using structured solutions capital preservation strategies may help to limit the extent of potential losses without entirely missing out on further gains.
