Developed Non-U.S. Equity Outlook

Q1 | 2019

By Keith Creveling, CFA - January 2019

Expectations for Non-U.S. Earnings Remain Positive

While uncertainty over trade policies and Brexit negotiations is weighing on corporate sentiment, the outlook for 2019 non-U.S. corporate earnings growth remains positive.

Our research indicates the recent underperformance of non-U.S. stocks is partially due to the divergence in growth rates, with faster growth in the U.S. during 2018. As we enter 2019, the market is adjusting to decelerating growth in most geographies, but the deceleration is most pronounced in the U.S., where the positive impacts of tax reform have largely been realized. Heading into 2019, this creates an opportunity for investing in non-U.S. developed markets as the divergence in earnings growth with the U.S. moderates.

We believe an active approach will be important. As monetary policy normalizes and interest rates rise, dispersion of stock price returns tends to increase. In addition, in an environment where inflationary pressures are increasing, growth is becoming less synchronized. Therefore, we think stock price performance will be differentiated based on company fundamentals. Correlation of stock price returns to earnings has normalized and intra-stock correlation of returns has declined.

  • Consider companies that may be less exposed to trade rhetoric and imposed or threatened tariffs. Stocks outside the U.S. may have the potential for stronger earnings growth as U.S. earnings and the recovery cycle mature.

Europe and Japan Land in Trade Crosshairs; Brexit Uncertainties Weigh on U.K.

As significant exporters to China, Europe and Japan are likely to be hurt by a general slowdown in global trade, but alternative suppliers may benefit. For example, in the lead-up to the G20 summit in December, China sought to replace its U.S. soybean imports with crops from Brazil and U.S.-made aircraft with Airbus planes from Europe.

Until we have some resolution of the current conflict, we’ve been evaluating companies’ ability to pass on higher costs through price increases to identify companies less likely to be adversely affected by a prolonged trade war. This is especially relevant for industrial stocks where we’ve divested those we initially saw as challenged by higher raw materials costs.

Globally, small-cap stocks may represent an area of relative shelter. Smaller companies tend to be more domestically focused with simpler supply chains generally less exposed to trade tensions and other global macroeconomic pressures.

As 2018 wound down, details around the U.K.’s exit from the European Union (EU) were undecided. The various parties in the U.K. and the EU itself were unable to agree on the question about a customs union or a method of avoiding a hard border between Northern Ireland and the Republic of Ireland. The uncertainty around the final arrangements for a deal, or if a deal can be reached at all, continue to cloud the picture for U.K. companies.

  • Reevaluate your portfolio’s regional and market capitalization exposures. Stocks with less exposure to U.S.-China trade tensions may offer attractive opportunities. Smaller-cap firms tend to derive more revenues from local sources and therefore may weather a prolonged trade war better than larger-cap companies.

Consumer Discretionary Stocks Benefit from EM Demand

We continue to see improving trends in demand for consumer discretionary goods in EM countries, driven by the long-term trend of an emerging middle class and their aspirational spending. We’re finding opportunities in companies based in developed markets and EM, including luxury retailers selling in China, consumer electronics companies with sales in Brazil, and global consumer discretionary companies distributing higher-quality brands.

  • Consider consumer companies positioned to take advantage of long-term trends such as EM consumer demand for higher-quality goods and services.

View the Full Investment Outlook

Q1 | 2019

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