Global equities enjoyed a strong start in 2017, driven by optimism about economic growth in the US and Europe. But political risk and valuation concerns undermined confidence toward quarter-end, highlighting a key dilemma facing investors this year.
Investor sentiment is being pulled in two directions. Will macroeconomic growth pull stocks up this year—or will political risk pull them down? This question was evident in the US, as stocks plateaued in late March after the government failed to pass a bill to repeal Obamacare. The move resulted from tensions within the Republican Party and dampened some enthusiasm about President Trump’s plans for tax cuts and fiscal stimulus, which had energized the market since the US election.
We believe that there are good reasons to stick with equities for the long term. And in the current environment, it’s especially important for investors to balance domestic and non-domestic exposures, as valuations and growth profiles differ from region to region.
EMERGING-MARKET AND GROWTH STOCKS REBOUND
During the first quarter, the MSCI World Index advanced by 5.4% in local-currency terms (Display, left). US large-cap stocks did well, though the rally in US small-caps that had been prompted by the election in November stalled. Emerging markets recovered from a setback late last year, as Chinese equities powered ahead. Japanese equities underperformed.
Most sectors did well. Cyclical stocks led global market gains (Display, right). Shares of resources companies underperformed as oil prices slipped modestly following their recovery in 2016. Growth and higher-quality stocks were back in favor during the quarter after underperforming last year. Value stocks disappointed.
POLITICAL RISK VS. MACROECONOMIC IMPROVEMENTS
Geopolitical risk is palpable around the world. Europe is coping with multiple flashpoints, from Brexit to the French elections this month to Italy’s huge debt burden and banking system crisis. In Asia, China is challenging several Asian nations over territorial rights in the South China Sea. Potential new trade barriers from the US are creating concerns for countries from Taiwan to Mexico. And conflicts in the Middle East continue unabated, with terrorist attacks spilling over to the West.
At the same time, global macroeconomic fundamentals are encouraging. In the US, robust consumer and business surveys, as well as strong job markets, have supported solid GDP growth since even before the elections. In Europe, manufacturing indicators point to a developing recovery, while the headline inflation rate of 2% in February met the European Central Bank’s target for the first time in four years.