This week’s focus: We prefer non-US equities
In a world of high valuations, elevated uncertainty about long-term growth and continued questions about politics and policy, investors are asking if there will be any more “happy returns” like those during the last eight-year equity bull market. We think non-US equities should outperform on a 12-month basis. Policy optimism and valuations are high in the US, and non-US equity markets have a better cyclical backdrop, are pricing more political risks (in case of Europe) and have less positioning. We also continue to expect global equities to outperform global bonds, but with lower absolute returns than in previous years.
In the event of a drawdown, we would expect cross-equity market correlations to be high, but in more flat markets (as we forecast for the S&P 500) we think the correlation decoupling we have already seen could continue (Exhibit 1). This is particularly true for MSCI EM, which is cheaper than other equity markets and appears to be entering another growth phase. Key risks to this view are rate risk and commodity prices. Our EM team has highlighted that the impact of higher rates depends on the source of the shock, its tenor and speed, and EM fundamentals; we expect a gradual increase in long-dated rates and see EM fundamentals as improved. Our commodity team also remains confident in higher commodity returns against a backdrop of good global growth. We think MSCI EM calls appear inexpensive, with at-the-money implied vol at its 9th percentile (Exhibit 28).