Equities and risk assets enjoyed a strong rally in the first half of 2019 as investor optimism was driven by hopes of a quick resolution to the U.S.-China trade dispute. But as uncertainty lingers on, the MSCI ACWI index has pulled back 3% from its July high while copper has declined over 15% since April. Still, U.S. equity leadership has remained a key fixture so far this year amidst weaker-than-expected European and Asian macroeconomic fundamentals. However, the most recent U.S. manufacturing statistics seem to point to a pending shift as the rest of the world appears closer to a bottom.
As highlighted in the chart below, the U.S. economy is now sporting the worst trend in PMI manufacturing surveys on a six-month and year-over-year basis. With manufacturing confidence waning, the outlook for U.S. profits and business spending should remain clouded in coming months, which, in turn, should most likely lead to more tame GDP growth.
Since changes in earnings leadership usually set the stage for a shift in performance leadership, we believe the U.S. equity domination will be hard to sustain as S&P 500 forward earnings estimates will potentially follow the ISM PMI’s lead in coming months.
As shown in the graph below, earnings revisions for the U.S. have easily outpaced Europe, Japan, and emerging markets in the last 12 months.
We expect this trend will reverse in light of challenges weighing on corporate America heading into 2020.
Although premium S&P 500 valuations have been a long-lasting source of discomfort for us, the risk of macro and earnings disappointment are the pillars of our significant U.S. underweight position (for equities and currency).
One of the key convictions in our global equity portfolios has been the pending reversal in U.S. equity leadership. Portfolio positioning is indeed defensive, but the game plan to gradually add cyclicals remains intact and has partially been implemented. The important decline in bond yields is not lost on us, and we have been gradually reducing exposure to “bond proxies”. When our assessment of our macroeconomic vector improves, our objective will be to further take advantage of opportunities where valuation and sentiment are looking increasingly attractive, i.e. value cyclical sectors such as financials, resources and industrials. The contrarian trade is taking us towards sectors that have been overlooked in recent years, and we believe we can take advantage of further market volatility to raise exposure to the value style in coming months.
Source of all data and information: Hexavest as at August 31, 2019, unless otherwise specified.
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