The war against COVID-19 is not over, but the path to victory has become clearer. Investors are anticipating the return to a more normal world.
Watch the Economic Outlook
Hello, I’m Jim Solloway, Chief Market Strategist and Senior Portfolio Manager in SEI’s Portfolio Strategies Group.
The war against COVID-19 is not over, but the path to victory has become clearer. Investors are anticipating the return to a more normal world. This is reflected in the rapid rise in bond yields, the most important change in the financial environment so far this year.
Higher bond yields may cause bouts of indigestion for equities, but they should not derail the bull market. We expect to see cyclical and value-oriented shares continue to advance relative to growth and defensively oriented sectors.
Historically, in most cycles, value shares have outperformed growth when the yield curve was rising or rates on long-term Treasury bonds were well above those on short-term securities. Value’s performance against growth bottomed on September 1st, and has been on a tear since.
While value-oriented shares have been making a comeback against growth in the US, other countries’ equity markets have been making a comeback against the US.
From the beginning of 2020 to the end of August, the MSCI USA index massively outgained the MSCI World ex USA Index. However, since last September, concurrent with the turnaround in the relative performance of U.S. value stocks cited above, the MSCI World ex USA Index has led.
Although not as highly priced as the valuation metrics found in the US equity market, developed-market shares outside the US appear expensive. Currently, the MSCI World ex USA Index is priced at almost 17 times the earnings per share forecast for the next 12 months, the highest level since 2004.
Developed equity markets, though, still look cheap compared to the US. The forward price-to-earnings ratio for the MSCI USA index is still above 22. The MSCI World ex USA Index therefore trades at an unusually wide 25% discount.
Although longer-term growth differentials justify a structurally higher multiple for US equities, rebounding economies and rising interest rates should lead to a narrower valuation gap.
The jump in US bond yields this year has raised investor concerns that emerging markets will be the victims of a 2013-style taper tantrum in which emerging market asset classes sold off as bond yields rose. While rising rates are a headwind, we believe emerging economies are generally in a better position to withstand the pressure than they were eight years ago. Strong growth in the world economy over the next year should help lift most emerging markets.
World trade volumes, for example, had already reached pre-pandemic levels by the end of last year. Over the course of 2021, the expansion in trade should continue. When trade volumes are strong, developing equity markets tend to perform well against those of the economically advanced countries.
We believe the economic backdrop strongly supports cyclical and value-oriented equities in the emerging markets, just as it does in developed markets.
The MSCI Emerging Markets Value total-return Index is highly correlated with industrial commodity prices, which have already vaulted higher from their year-ago lows. We project that more commodity price gains are on the way. Strong manufacturing and construction demand in the US and China, recovery in Europe and Latin America as vaccines become more widely available, the global push into electric vehicles and other climate projects, and the major infrastructure package that is next on the Biden Administration’s to-do list all promise to stoke demand for metals and other commodities.
Emerging economies also look less susceptible to a 2013-style taper tantrum because their external positions are much healthier. Current account balances as a percentage of GDP are generally much smaller now than eight years ago. Several developing countries now sport current-account surpluses instead of deficits.
Emerging-market local-currency and US-dollar bond yields have moved higher this year, but the increase has so far been quite modest. In fact, their spreads…or the extra yield they pay over comparable Treasurys for assuming additional risk…are still near their lows of the past three years, certainly not qualifying as a taper tantrum.
Developing countries will likely take longer to reopen fully since vaccination distribution will take time. Yet, even these countries will benefit economically from the upswing in developed-market consumer demand.
Since markets are forward looking, they tend to look past today’s events and toward expectations for the future. The current state of the global equity market paints a picture of a potentially bright future as vaccines make their way around the world.
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