DAILY SKETCH - My outlook on equities is slightly negative

    • Daily sketch

I have now a slightly negative outlook on equities. At the Investment Committee on February 3, we decided to reduce the weight of the global equity component vis-a-vis benchmarks from -12.5% to -25.0% between neutral and minimum. There were primarily three reasons for this step. First, the very solid performance of global stock indices since the beginning of this year and over the last 12 months. Second, very high global equity valuations (see chart below). And third, the risk of rising inflation due to the unprecedented quantitative easing of key central banks and still very loose fiscal policies. At the same time, according to historical statistics, it has always been the case that with higher inflation, equities did not perform very well. I therefore believe that the expectations of a very positive future development have already been priced into the current stock prices and the scope for further significant equities growth is already significantly limited.

DAILY SKETCH - My outlook on equities is slightly negative On the other hand, I must emphasize that the overall overvaluation of global stock markets is mainly due to the extreme overvaluation of US stocks. We therefore have them significantly underweighted against benchmarks in our global equity allocation. If my expectations are met and US stocks fall significantly behind the rest of the world in the coming months, this will have a very positive effect on the relative performance of our portfolios against benchmarks.

On the other hand, I believe that some regions of emerging markets continue to be valued very attractively. These include, in particular, the Central European region, which has lagged far behind global stock indices in recent years. Central Europe is currently probably the cheapest region in the world with the trailing P/E of approximately 16x. The Central European region is therefore significantly overweighted in our global equity allocation relative to benchmarks. I firmly believe that investors will find their way to this region again in the coming months.

Another region that we have significantly overweighted in the global equity allocation is emerging Asia, led by China. This region has performed very well in recent quarters and our investment portfolios have benefited significantly from this development. At the same time, I firmly believe that the outperformance of this region should continue for the rest of this year. Emerging Asia is currently the economic engine of the whole world. According to the latest forecast of the International Monetary Fund, India's GDP should grow by 11% this year and China's GDP by 8%. This, of course, should have a significant positive effect on the dynamics of corporate earnings of local exchange-traded companies and thus on stock performance.

At the same time, we have been very pleased with emerging markets as a whole recently, as since the beginning of this year, emerging markets according to the MSCI Emerging Markets index have gained 3.7%, while developed markets according to the MSCI World index "only" 1.4%. I believe that emerging markets as a whole should outperform in the coming months, primarily for valuation reasons. According to the EV/EBITDA indicator, developed markets are currently valued at the level of 17x, while emerging markets are only valued at the level of 14x. In emerging markets, there is thus a 17% valuation discount, which in our opinion should be completely neutralized in the coming months.

One of the key risks to my slightly negative scenario for global equity markets is the fact that key central banks are still buying assets on an unprecedented scale (quantitative easing). From a global perspective, central banks printed $ 9.2 trillion last year, three times the previous record from the crisis of 2008. So I can't rule out that global stock markets will continue to grow from current historical highs, as the correlation between global equity indices and the global money supply has indeed been very strong since the global financial crisis.
Michal Stupavský
Investment Strategist at Conseq Investment Management, a.s.


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