For the remainder of the year and 2019 I am optimistic, as we should return to the fundamentals. In fact, the correlation between assets has dropped a lot and now active investment managers can generate value by identifying the best opportunities. So the next two to three years the active manager should be one of the clear winners. Even in fixed income there are managers capable of generating real profitability, that is to say, outperforming inflation, either with relative value bets or by actively managing duration.
Keep in mind that central banks were injecting more than two trillion dollars in 2015 or 2016 into the world economy, but in 2017 it was 940,000 and this year only 480,000. In fact the rate of reduction of the Federal Reserve’s balance sheet will reach its maximums this October and the ECB’s asset purchase program reach to an end this year. This reduction will make the buyer of last resort disappear and it is possible that some momentum in the markets will be lost. So you have to prepare yourself, because the opportunities, more than in macroeconomics, are going to occur in the fundamentals of the companies.
For now, our global cycle indicators indicate economic growth, corporate profits and so far the lack of consequences of the trade war, which compensates for this withdrawal of liquidity. But the consequences of the increase in interest rates in the US are beginning to be seen in construction and residential investment, although China has moderated the de-leverage and its main indicators they have bounced back. Its low spending on infrastructure has been offset by growth in residential housing.
In addition, the European stock market can be one of the positive surprises. Europe equities are much cheaper than the US and the Fundamentals of the companies are not being reflected in the prices. There is a lot of political noise and we see an opportunity in 12-18 months, although, in the absence of a clear catalyst, for the moment we are neutral.
Japan is also interesting by valuation. It is the cheapest developed market equity market, while the US market it is the most expensive. The Bank of Japan continues to inject liquidity (at a slower pace but with expectations of more equity purchases), while the Federal Reserve has raised interest rates for the third time this year. Japanese stocks are attractive, based on leading indicators, yield to maturity on their bonds, and the yen’s exchange rate, which is 26% below what it should be compared to its global peers.
There is also value in emerging markets, although in the short term there may be volatility. Specifically, dDepending on the risk profile, it is convenient to look at emerging debt in local currency, whose yield to maturity is 6.5%, with a 3% premium compared to high yield credit and listed currencies with a discount of twenty%.
It should be borne in mind that the main activity and earnings indicators remain resilient in the vast majority of these economies – earnings growth expectations this year and the following have remained more or less stable – and we do not expect the dollar to rise much more – it has risen 37% weighted since July 2011, its highest valuation in a quarter of a century. Furthermore, as a whole, the current account surplus in these countries has increased from 0.1% of GDP in 2013 to 0.8% today. Even among those countries with a public deficit, it has fallen to 1.7% of GDP compared to almost 4% in 2013. Even inflation has remained below the long-term average, having fallen almost continuously from 2012 to 3%, almost 2% less than the average of the last Two decades.
In addition, many emerging market companies have not borrowed in dollars and many exporters and companies, such as those operating in mining and oil, generate income in dollars with costs largely in local currency.
Furthermore, we consider the state of affairs in Turkey, Argentina and South Africa to be idiosyncratic. At the same time, the political map in Latin America is clearing, with López Obrador elected president in Mexico and Bolsonaro with possibilities in Brazil. It must be taken into account that the region has macroeconomic duties and this reduces uncertainty. In fact, Bolsonaro’s pro-market program should help companies with interests there. The second round is missing and a turn towards a different game would be a historic milestone. The fact is that Brazil’s credit spreads compared with Colombia or Mexico have expanded excessively and some assets are attractive.
To this is added that the US Treasury bond is the only one from developed countries that we consider. Although the value of the US bond is affected by the expectation of interest rate increases from the Federal Reserve, its yield to maturity in ten years is above 3%, compared to negative real yields in European fixed income and provides coverage low cost in the face of market volatility.