Global equities: Brace for slow growth, rising rates and political uncertainty

Matt Moody, vice-president, investment management and a member of the Mackenzie Ivy team at Mackenzie Investments. The team’s wide range of mandates includes Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class. The Mackenzie Ivy team seeks to buy high-quality businesses and not overpay for them.

Michael Hatcher, head of global equities and director of research at Trimark Investments, a division of Toronto-based Invesco Canada Ltd. A value manager, Hatcher’s extensive responsibilities include that of lead manager of Trimark Fund and other key mandates such as Trimark Global Fundamental Equity and Trimark Global Dividend Class.

This three-part roundtable series continues on Wednesday and concludes on Friday.

Q: There are many challenges for global equity market managers, given the political uncertainty on a number of fronts, muted global economic growth and a global equity market that is expensive.

Moeschter: On the political front, the global financial crisis precipitated the push for change among governments, regulators and voters. Many voters lost their jobs and money during this crisis and were generally dissatisfied with the outcome. You’re seeing the rise of some radical parties in Europe and non-conventional politicians, such as Donald Trump in the United States. People want change. They don’t want the establishment. This is the voter mood and it’s not going to go away. We were surprised by both the Brexit vote in June and by the outcome of the U.S. election on Nov. 8. These upsets are likely to continue. Europe is facing a few elections next year. Even if the voters in these elections don’t elect a non-conformist, these non-conformists are going to be in a position of influence. There is often a coalition government that has to accommodate the new parties.

On the world stage, we have probably seen a peak in the impetus to sign new trade agreements and we might see some retrenchment from existing agreements.

Hatcher: My concern is that this populism will lead to more protectionism in the long term. The trade barriers could start to go up. This is a potential negative for global economic growth. Generally, citizens of one country are seeing the impact on them of forces outside of their country, as being a serious problem. That’s what Trump has been saying and that’s what happened with Brexit.

Q: How will these changes affect multinational companies? These form a substantial part of your global equity portfolios.

Moeschter: Certain companies might benefit from the corporate tax cuts that could be implemented in the United States. It should be emphasized that while there’s been a change in direction in the United States, following the Nov. 8 election, this doesn’t mean that investors should be viewing their portfolios differently.

Moody: The recent unexpected political developments show us how difficult it is to predict such changes. We try to remove this from our investment process as much as possible. We look for companies that can survive and thrive over the next 10 years, more or less regardless of what is thrown their way. There are a number of companies that have been around for more than 100 years and have been through a lot more challenging times than the ones they’re experiencing currently. Our basic assumption for European and developed markets since the financial crisis is that there will continue to be pretty weak growth over the long term. We haven’t changed our outlook or assumptions based on the developments over the last six months.

Hatcher: It’s going to be a tough slog for the global economy. There will be volatility in the global equity market. This is a good environment for investors, as it provides opportunities to both buy on a dip and sell stocks on a rally. It’s a good environment for stock pickers.

Q: The global equity market is expensive. The price/earnings ratio on the benchmark MSCI World Index, which represents 23 developed markets, was 21.5 on a trailing basis at the end of October.

Moody: Valuation is an issue. The cash weighting in Mackenzie Ivy Foreign Equity was 32% at the end of October. A year ago it was 27%. This is all to do with valuation in terms of the companies that we own or would like to own. Valuations have not been attractive for a few years now.

Moeschter: In many ways the market’s price/earnings multiple makes sense. Interest rates have come down, there is some earnings growth and certain sectors have seen an expansion of their multiples as investors have re-rated these stocks. Examples are the consumer-staples sector and regulated utilities. If you’re in a low-interest-rate environment, dividends are most appealing.

Q: In U.S.-dollar terms, the U.S. equity market constituted 59.3% of the MSCI World Index at the end of October and all the top-10 stocks in this benchmark were headquartered in the United States.

Hatcher: If the U.S. economy gets the stimulus package that Trump has talked about, that’s a positive, but if interest rates start to creep back up, this creates a bit of a wash. A rising interest-rate environment will create headwinds, for example, when it comes to debt servicing.

Moody: The expectation is that the U.S. Federal Reserve Board will increase the federal funds rate in December. We view this as a positive, as the Fed funds rate went down to zero during the global financial crisis and stayed there until December last year. There are negative interest rates in a number of economies. This distorts financial markets and leads to a misallocation of capital. We see a move to return interest rates to more normal levels as healthy. There could be a short-term negative impact of a rise in rates on the equity market, but if there’s a correction, it could be healthy. In our view, the valuations far exceed the fundamentals in a lot of cases.

Q: Coming back to the multinationals, how will a move to more protectionism affect their ability to operate?

Hatcher: Many of the multinationals have both their revenue and expenses in the big geographic regions. They are quasi-local in that sense. It will affect companies that are, say, pan-European and are selling into the United States, rather than having a U.S. operation. Multinationals are probably the best positioned if certain trade barriers are raised, as they are already predominantly local companies.

Moeschter: President-elect Donald Trump has talked about tax reform that would allow U.S.-domiciled multinationals, some of which have large overseas profits, to repatriate those profits at a lower tax rate. It could be positive for some companies.

Moody: I agree that multinationals are in a strong position to deal with the changes that we’ve discussed. Not too many companies are truly domestic. They often import the products or components for the products that they sell. They may have a tougher time if trade barriers are raised. We generally prefer multinationals. They’re better able to handle a complex environment. They’re not overly reliant on any one nation or any one set of trade policies.

Q: What are your main concerns about the global economy, political trends and the equity market going forward?

Moody: We’re concerned about aggressive central-bank actions, not just in Europe. We have seen interest rates go to zero and below. What worries me is that the central banks don’t seem to be worried about the distorting impact of their policies on the financial markets. They opt for an aggressive stimulus approach. If this doesn’t have the desired effect on their economies, their conclusion is to do more. In terms of the global stock market, my concern is about the extended valuations that we’ve discussed.

Moeschter: On the political front, I worry that some radical parties are getting more popular support in Europe. This might lead to problems with consumer confidence and with corporate confidence and could negatively impact economic growth. There is a concern that more extremist views will prevail or influence the respective governments’ decisions. In Eastern Europe, there are some governments that have been elected that have pretty hard-line views.

Hatcher: There are so many macro factors such as interest rates, currencies and the price of oil that could influence stock-market returns over the next five to 10 years. It’s important to stick to your investment discipline, but be conscious of the fact that these uncontrollable macro factors are going to have a relatively large impact on returns.

This three-part roundtable series continues on Wednesday and concludes on Friday.