Stephen Cohen (pictured), Chief Investment Strategist for iShares EMEA, comments on areas of opportunity for a winter rally, regardless of the weather…
Over the past two weeks, equity markets have become increasingly volatile. Equity volatility, as measured by the VIX index, is currently at 21.3, having stayed below 15 for the best part of 2014. Investors have been worrying about global economic growth – some regions are not seeing their economies, such as the Eurozone, grow much at all. Other developed economies, including the US, are growing but data on jobs, manufacturing, business confidence is not all positive. Concerns about whether the US Federal Reserve, will finally start on its path of policy normalisation are also weighing heavily. Nonetheless, with the last quarter underway, there are a few areas where we see the opportunity for a winter rally, regardless of the weather.
In the developed world, Japanese equities seem to offer the most value. Japan’s largest pension fund, the Government Pension Investment Fund, which has US$1.2trn in assets, is looking to allocate more to domestic equities which should help support the market. A weaker Yen versus the US dollar compared to earlier this year is also boosting the earnings of Japan’s exporters. With weaker growth, the Bank of Japan is likely to keep its foot firmly on the easing pedal. Investors could consider accessing Japanese equities through a currency hedged strategy, given the strong relationship between a weaker currency and a stronger equity market.
In the US, the shares of larger companies have been gaining ground versus their smaller company counterparts since March this year. We think that there could be more to go as US large caps are still on a very attractive value discount compared with small caps. Small caps rallied by more than large caps during Quantitative Easing as the Fed injected a huge amount of liquidity into the market. With policy normalisation on the horizon, some of that outperformance of small versus large caps might be given back.
In emerging markets, uncertainties ahead include the uncertain growth path of the Chinese economy and US dollar strength. Differentiation by country is the name of the game in this stage of emerging market investing. We are looking at India, Taiwan and Korea because of reform expectations, economic growth potential and strong external balances respectively. Emerging Asia, meanwhile, has an attractive combination of valuation and growth outlook.
European credit could benefit from any supportive stance by the ECB and from low inflation, or slight deflation with low growth. An unwinding of the sharp rally in core government bonds could also benefit interest rate hedged credit. The significant widening of spreads in US high yield is creating some value, given default rates remain low.