U.S. earnings lead is reversing
U.S. equities ruled over the rest of the world for most of 2018, with the domination fueled by a significant profit lead for American corporations. MSCI U.S. EPS growth tallied north of 20% in 2018, double the rate for EAFE and emerging markets. Consequently, this profit domination has lifted the MSCI U.S. premium to 25% over the World ex-U.S. based on forward P/E multiples*. Still, the U.S. index performance advantage faded somewhat in the fourth quarter as signs of slowing domestic momentum erupted through weaker auto and housing activity. U.S. retail sales also ended 2018 with significant weakness in December, which is somewhat of a surprise considering still buoyant employment conditions and declining gasoline prices. More recently, earnings revisions have turned negative across the world, and the U.S. has been following this downward trend, as highlighted in the following chart. We believe sustaining price leadership will be challenging for U.S. equities, as premium valuations will have to answer to a weakening earnings outlook.
The China angle
Chinese crosscurrents (U.S.–China trade war domestic slowdown) were notable headwinds for risk assets** in 2018, lending even more shine to the U.S. exceptionalism story. Global trade was challenged by slowing Chinese demand, and both German and Japanese industrial production were among the key casualties. Hence, the macro highlight of 2018 was how the U.S. economy resisted the global slowdown, but 2019 could see a reversal of fortunes, as the U.S. economy is now showing faltering signs. Our macro view for China in 2019 is that the slowdown could trough by midyear with a pickup expected in the second half, a scenario supported by the rising possibility of a trade agreement with the U.S. and additional government stimulus. Improving macro visibility in China could also provide a tail wind for companies outside the U.S. who benefit the most from global trade. The graph below illustrates the domestic bias of U.S. companies’ revenues exposure with Europe and Japan taking a large share of foreign revenues.
Since Chinese equities and emerging markets have apparently priced in the negative news flow related to the trade tensions, our view is that the risk-reward outlook for emerging markets, Chinese equities and Japan is superior to the U.S. As for Europe, the geopolitical uncertainties in France (gilets jaunes) and the U.K. (Brexit) are negative factors we take into account in our macroeconomic analysis. This being said, we believe Europe provides a better alternative than the U.S. as European companies seem more likely to benefit from a pickup of the Chinese economy in 2019.
*Sources: IBES, MSCI, Datastream, December 31, 2018.
** Equities, commodities, corporate bonds, emerging market bonds, emerging market currencies, and commodity currencies.
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