Each quarter, our Global Equities' senior investors, led by Paul Quinsee, meet to discuss current trends, best opportunities, and key risks in global equity markets. Our 3Q 2017 Global Equity represent the output of this meeting.


• The combination of broadening economic growth and contained inflation is driving strong earnings gains. In 2017, profit growth was the major source of total return for emerging market (EM) equities, which are still approaching only the middle of their performance cycle.

• We expect disinflationary slack will disappear from most of the developed world in 2018, so any acceleration in economic growth from this point could present late-cycle complications.

• Despite extended outperformance by EM information technology stocks, we do not see a bubble in the making. Earnings have fueled the gains, and multiples for the sector remain well within normal ranges.

• Although U.S. valuations do appear a little heady, EM valuations are well below their long- term average, even after the multiple expansion of recent years.

SO MUCH FOR INVESTOR COMPLACENCY. Recent market volatility has reminded us all that equity prices can suddenly lurch, and sometimes for no apparent fundamental reason. In early February, as markets wobbled, recovered and wobbled again, we reaffirmed our outlook for emerging markets. Emerging Market Asia Pacific (EMAP) companies are poised for continued earnings gains amid self-reinforcing global growth and well-contained inflation, with the added tailwind of a weakening U.S. dollar. EMAP equities, we believe, are approaching only the middle of their performance cycle.

As 2018 gets underway, we look back-emerging markets were the best performers in 2017-and forward to consider the potential for what we think of as late-cycle complications. Is the information technology (IT)-led boom a bubble in the making? (The short answer: no). Can global central bankers achieve a hoped-for gradual normalization as they unwind their swollen balance sheets? (The likely short answer: yes.) We address these issues below, concluding, as always, with some actionable investment ideas.


By almost any measure, macroeconomic data look impressive. Manufacturing PMIs (purchasing managers’ indexes) for both developed markets and emerging markets are strong, and virtually all economies are in expansion mode. We see this as unambiguous evidence that global growth is now self-reinforcing. Not surprisingly, the depth and breadth of global growth are spurring expectations for accelerating GDP growth.

Emerging market equity was the best performing stock market in 2017, with most of the returns driven by earnings growth


Source: J.P. Morgan Asset Management; data as of December 2017.

All in all, it’s a welcome backdrop for earnings growth, and, indeed, rising profits have spurred greater equity returns. As illustrated in EXHIBIT 1A, earnings growth was the major source of total return for EM equities in 2017, far surpassing multiple expansion or the currency effect. That’s quite a reversal from the prior year, when EM equity valuations moved dramatically off their January 2016 lows.

Breadth is improving at the country level



Source: J.P. Morgan Asset Management; data as of January 31, 2018.


Amid a synchronized recovery, what happens if global growth accelerates from here? As we have said in prior quarterlies, we believe that the so-called old paradigm explains the “Goldilocks” environment that has prevailed for risk assets—that is, strong growth and contained inflation, even multiple years into the global expansion. That is largely because output gaps in both developed and emerging markets were merely recovering from their disinflationary levels of 2009 (the Great Recession left its mark). But because we expect 2018 will be the year in which the remainder of that disinflationary slack disappears in most of the developed world, acceleration in economic growth from this point is no longer unambiguously positive for risk assets. It presents late-cycle complications, as the “not too hot, not too cold” combination of solid growth, modest inflation and well-anchored bond yields could begin to fray.

Bubbles-in-the-making are another potential late-cycle complication, and some are wondering whether the extended outperformance of IT stocks-led, in emerging markets, by BAT (Baidu, Alibaba and Tencent)-reflects a growing bubble in the sector. Certainly, performance has been impressive-a 40 percentage point outperformance by the sector since EM equities bottomed in early 2016. But it’s not a bubble, in our view. That’s because earnings growth has fueled the boom, while sector multiples remain well within normal ranges.

Central bank balance sheet normalization presents a particular sort of complication-as quantitative easing was unprecedented, so, too, will be its unwinding. Developed market (DM) central banks are now in the early stage of balance sheet normalization; in all likelihood, 2018 will be the year in which net purchases by DM central banks begin to decline.

Central banks are keenly aware of the challenge they face, and their messages to investors have repeatedly emphasized that balance sheet reduction will be gradual. There is a risk of sustained and substantial market disruption, but we see the possibility as fairly remote. Further, the ultimate target size of a central bank balance sheet-specifically, its size relative to GDP- is probably bigger than we might once have expected. It is very unlikely that the balance sheet-to-GDP ratio will return to the single-digit level that prevailed for much of the past 50 years.


We turn now to a consideration of equity valuations. As we have noted, EM equity valuations have moved substantially higher in recent years, but it’s important to remember that their starting point was extraordinarily low. The ratio of price to 10-year earnings average was just 10.5x in January 2016; today that multiple is still modestly below its long-term average. In the U.S., on the other hand, equity multiples are well above their long-term average even after the gyrations of recent days (EXHIBIT 2). In short, while we believe EM equity valuations are quite reasonable, we are paying close attention to increasingly heady valuations in the U.S. and are monitoring them for any potential spillover effects on emerging markets.

Finally, we consider what is happening within EMAP markets, beginning with currency. As the U.S. dollar weakened last year, we thought it was still possible (although not likely) that a catalyst might emerge to give the USD one last surge higher- perhaps from a new Federal Reserve chair, tax reform or rebounding inflation. But after a new chair, Jay Powell, took the helm of the Fed, tax reform passed and some inflation data flickered higher, the dollar essentially shrugged off all challenges to its retracement cycle. At current values, we think the dollar is still slightly overvalued, while most EMAP currencies appear below or near fair value. (The Egyptian pound is the lone hyper- cheap currency.) The rally in oil prices has had limited impact on oil currencies, with the Russian ruble more or less fairly valued and the Colombian peso still measurably undervalued.

At the country level, where we tactically seek combinations of attractive valuations and positive momentum, we continue to favor Korea and smaller Eastern European markets, despite their strong performance in 2017. Brazil looks to be neutrally valued, while economic data and earnings momentum confirm the end of the country’s recession. Among higher risk, deep- value countries, we find slightly more value in Turkey compared with Russia, as relative valuations are modestly closer to extreme discounts, even though Turkey is on the wrong side of the oil price action (while Russia is on the right).


A story of self-reinforcing growth is unfolding across global markets, and we feel confident it will continue for a good while yet. We believe that emerging markets are approaching only the middle of their cycle, as earnings growth, with impressive breadth across sectors, drives performance. Although U.S. valuations do appear somewhat extended, EM valuations are well below their long-term average even after the multiple expansion of the past two years. For those who stay invested, we see the potential for meaningful gains in the coming year.

EM multiples are still modestly below their long-term average, while U.S. multiples are well above, even after recent market gyrations



Source: IBES, MSCI, J.P. Morgan Asset Management; data from November 1979 to February 5, 2018. PE = price earnings. GEM = global emerging

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George Iwanicki


Emerging Markets Macro Strategist,
Emerging Markets and Asia Pacific Equity Team,
J.P. Morgan Asset Management

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