We favor U.S. and emerging market (EM) equities for tactical global allocations. After reviewing our thoughts on the U.S. equity markets in last week’s Weekly Market Commentary, we thought we’d expand our 2018 equity outlook with a focus on global markets. As discussed in our Outlook 2018: Return of the Business Cycle publication, from a regional perspective, we favor the U.S. and EM over developed foreign markets broadly, although the improving outlook in Japan is noteworthy.
International Equities Performance Review
The year 2017 was excellent for international equities, especially for EM. The MSCI EAFE and EM indexes returned 25.6% and 37.8%, respectively, both ahead of the S&P 500 Index’s 21.8% return. International equity market gains were broad based, as only two MSCI World countries saw their markets decline in 2017 (Russia and Israel). In general, overseas equity markets benefited from U.S. dollar weakness, improving and better-than-expected global growth, a rebound in earnings, and commodity gains.
Within the developed international benchmark, Europe slightly outperformed while Japan slightly underperformed. Within EM, where strength was led by China, some of the risks carried more bark than bite; U.S. trade relations with China and Mexico soured less than feared, while EM generally shrugged off Federal Reserve (Fed) rate hikes and the start of balance sheet normalization.
International Equities 2018 Outlook
We evaluate regional allocation opportunities by looking primarily at the following factors:
From a regional perspective, our 2018 economic growth outlook favors the U.S. and EM over developed international economies. For 2018 we forecast gross domestic product (GDP) growth of 2.75–3% in the United States, after factoring in the potential impact of the new tax law, and 4.8% in EM, compared with 1.8% in international developed economies, and 3.7% globally.*
Growth in the Eurozone gained traction over the past year, with improving business confidence leading to higher investment as the worst of the political fears failed to materialize. However, uncertainties remain amidst the surge in nationalism, Brexit negotiations, and the upcoming elections in Italy. Considering these challenges, along with a reduction in European Central Bank (ECB) monetary support, it is conceivable that European growth may have peaked.
In Japan, economic growth prospects have brightened. The combination of government spending and monetary accommodation has pulled GDP higher for seven consecutive quarters. While GDP growth is expected to hover around 1.0%, inflation is projected to remain well below the Bank of Japan’s (BOJ) 2.0% target, which may keep the zero percent target for the 10-year Japanese government bond in place for the next year or two. Prime Minister Abe has a mandate for more stimulus and structural reforms after his election victory last fall.
We expect economic growth near 4.8% in emerging economies. Advantageous demographics, stable commodity prices, and early-cycle acceleration should help offset slowing but stable growth in China. We expect China’s GDP to expand near 6.5%, down slightly from 2017 estimates of 6.9%, supported by the powerful combination of gains in retail sales and industrial production.