US economic expansion will continue at a mature phase of the cycle, which should be supportive of global equity markets, although investors should not expect a smooth ride, according to James Ashley, head of international markets strategy at Goldman Sachs Asset Management.
“Emerging markets, especially, have upside, but markets will be susceptible to geopolitical shocks,” he told a media briefing in Hong Kong today.
In broad terms, he favours equities over credit, and credit above sovereign bonds.
However, his three-tier grading is “not universal”. Instead, he advises investors to be “granular about stock and bond selection”.
Ashley’s confidence is largely predicated on the view that the US economy will continue to grow at a “mature stage in its cycle”, and not slide into recession.
“The US will be the engine for global economic growth, and even though its equity markets are reaching new highs, the decline in the risk-free rate to 2.5% from the usual 4.5% means that valuations are not stretched [the risk-free rate is used as a factor to discount a company’s future earnings],” he said.
He expects the US Federal Reserve “to maintain an accommodative monetary policy, but not to act aggressively”. It cut interest rates this year as insurance against recession, but economic growth is likely to be close to trend at 2%, unemployment is at a 50-year low and core inflation is stable at around 2%.
In contrast, Europe faces structural and cyclical challenges that include below trend economic growth, an output gap and persistent political uncertainties.
Fiscal stimulus will likely take a more prominent role in boosting flagging economies, although Ashley sees room for further interest rate cuts by the ECB — despite a negative policy rate already — and thinks it will continue quantitative easing.
“European equity markets will be alpha- rather than beta-driven. Investors need to find specific pockets of value, for instance in Spanish stocks and European financials,” he said.
Ashley is neutral on US treasuries, having shifted from underweight since the 10-year bond’s yield move back to “fair value at around 1.9%”, and has a small overweight to core and peripheral European government bonds, whose yields could fall further despite new supply from fiscal stimulus measures [that is, borrowing].
Emerging market tilt
Many emerging markets should benefit from weaker oil prices and low US interest rates which will cap dollar strength, argued Ashley.
More specifically, he recommends overweight positions in high yielding Latin American dollar-denominated bonds and South Korean local currency debt as the won continues its recovery from early 2019 lows. This a sharp reversal from GSAM’s decision to underweight emerging market debt last May.
His top pick among emerging market equities is India, because of the electoral mandate for prime minister Modi to press ahead with reforms and due to “positive demographics”, as the country’s young population becomes richer.
His India optimism is in sharp contrast to Moody’s, which last week downgraded India’s outlook to negative from stable, citing “increasing risks that economic growth will remain materially lower than in the past, partly reflecting lower government and policy effectiveness at addressing long-standing economic and institutional weaknesses”.
Ashley has a “slight overweight to China”, because “domestic policy makers will ensure that China’s transition to lower trend growth of 5%-5.25% next year, will be achieved in an orderly fashion”.
Although Hong Kong has slipped into recession and remains vulnerable to political uncertainty as the protests enter a sixth month, and is subject to “external headwinds from the trade dispute”, its market is likely to benefit from the long-term structural changes underway in mainland China, according to Ashley.
He favours overweights to the Indonesia and Vietnam markets, where some companies are beneficiaries of the Sino-US trade conflict. On the other hand, he has a negative tilt towards Thailand and Taiwan, because they don’t offer “attractive individual stocks at present”.
Ashley’s recommendations are reflected in the portfolio of the $2.8bn Goldman Sachs Emerging Markets Equity Portfolio Fund, which is authorised for sale to Singapore and Hong Kong retail investors.
Goldman Sachs Emerging Markets Equity Portfolio Fund
Source: Fund Factsheet, September 2019
GS Emerging Markets Equity Portfolio Fund vs benchmark and sector average