Goldman Sachs' 2015 global equity views and themes note is out and its title "The Long Grind Higher Continues" says it all... it's muppet slaughtering time...
As we look into 2015 we have several broad views on equities:
- Overall returns are likely to be somewhat lower in 2015 and beyond compared with average returns since 2009, particularly in the US
- But we continue to expect much better returns in equities than bonds
- We see higher local currency returns outside of the US, but much more similar returns in common currency as we expect the dollar to strengthen further
- While differences exist across markets there are common themes – positioning for dollar strength and growth differences (US relative to Europe for example) is one, and looking for total cash returns is another
- The regions with the most monetary policy easing are also the ones with the best return forecasts
1) More specifically, in terms of the overall returns, the exhibit below shows the forecasts that we have both for 2015 and, on a CAGR basis, out to 2017. Total returns (including dividends) are expected to be lowest next year in the US at 3% and highest in Japan with a forecast rise in Topix of around 21%. However, when adjusted for currency most markets are expected to enjoy similar high-single-digit returns; given smaller FX moves, Asia becomes a better prospective performer than Europe. The CAGR between now and end 2017 on our forecast implies a much lower return than we have generally seen since the market lows in 2009. On average global equity markets have achieved an annualised return of around 20% since this trough, while we are now expecting CAGRs of between 3% and 11% (again with Japan as the highest and the US as the lowest) in local currency.
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2) Nonetheless the expectations for still low inflation mean that these expected returns are still quite high in real terms relative to history, with the exception of the US where they are slightly below (38th percentile). The chart below shows our expected 1 year total real return forecasts relative to the historic distribution of 1-year annualised total real returns in the US.
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3) More strikingly our forecasts suggest much better returns in equities than in government bond markets. While we expect bond yields to rise through next year, we expect the increase to be moderate, even in the US where policy rates are forecast to rise in 3Q. A rise in Fed funds rates is likely to impact the US market and compress valuation multiples moderately. It is also likely to maintain the rise in the dollar which, as yet, has only started what may be a multi-year appreciation. Specifically we expect the euro to fall to $1.15 by end 2015 and the yen to reach 130/US$.
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4) Looking at the regions, we see the biggest absolute rise in Japan, where Kathy Matsui and team have emphasised a number of supportive factors. First the recent expanded and open-ended QQE, the GPIF’s new asset allocation, the VAT hike postponement and, next year, cuts in the corporation tax rate that reflect the important support from a policy perspective. These are likely will be bolstered by a number of important reforms in 2015 including the launch of the taxpayer ID system, immigration reforms, the re-starting of the nuclear plants and also the female participation package. Second, these policy measures are backed by improving fundamentals; record ROEs, steady top-line growth and the weaker yen. Third, valuations remain attractive by historical comparison with the FY2015E P/E at 12.7 and P/B at 1.3x. Fourth, structural reforms are finally taking hold with a strong focus on shareholder returns pushing dividends and buy backs to record levels (1HFY2014 dividends reached a record Y3.2 tn and share buybacks rose 58% yoy).
5) In Europe the fundamentals (both economic and profit growth) remain poor. For the euro area, GDP is expected to rebound only moderately by 0.9% while the UK GDP growth is expected to slow to 2.8%. Corporate profits are now rising, but only just; we expect 2014 to see 3% profits growth with a rise to 6% in 2015, over 60% of which is driven by financials. However, as we described in our outlook, while our central scenario was for a modest rise in the main European markets, the risks were to the upside given the potential for policy intervention to reduce the implied risk of deflation. Mr. Draghi’s speech last Friday suggested that the chances of outright sovereign bond QE had become more likely than not for 1H2015. If the ECB adopts QE we would expect it to do so decisively with a bold and large programme. While by no means a certain outcome, and with limited probable impact on long-term growth, this possible crossing of the rubicon could be game changing for markets. The equity risk premium remains very high – a 1 percent fall is worth around 20% on the SXXP. As with the policy interventions that followed the ‘do whatever it takes’ comment in the summer of 2012, there is plenty of scope for a lower risk premium to boost valuations and add to the returns. Furthermore, investors have become very sceptical. The most recent US balance of payments TIC data shows that US investors sold a record net €27 bn in September alone. We have recently upgraded our forecasts to reflect the rising probability of QE and are now expecting 390 on SXXP by end 2015 (roughly 12% price return) and 3800 on SX5E (roughly 17% price return). Within Europe we favour MIB and IBEX as we also recommend a long position in a basket of 10 year sovereign debt in Spain, Italy and Portugal relative to France and Germany.
6) For Asia Tim Moe and team expect single-digit earnings growth for both 2015 and 2016 and, with little room for valuation expansion, forecast the Asia pacific ex Japan (MXAPJ) to reach 520 over 12 months, a price return of 9%. However they see quite wide dispersion across the markets with their favourites being Indonesia (raised to overweight) and Taiwan, China, India (staying as overweight). An additional attraction for Asia is its exposure, in parts, to a stronger US economy and lower FX risks than for Japan and Europe. Meanwhile under the hood there are some exciting opportunities that include beneficiaries of reform, mainly in China and India, the growth of the internet in India, Taiwan (the Internet of things theme) and mega caps in Korea.
7) The US market has enjoyed a strong period of outperformance and for good reason. Growth is strong; our current activity indicator puts it at over 4% with the prospect of 3% or more growth through to 2017. Nonetheless, profits have reached an all-time high and growth is now slowing. David Kostin and team expects just 5% profit growth over 12 months, half the current bottom up consensus. Meanwhile the prospect for policy rate tightening within a year is likely to finally push the multiple down moderately. The combination leaves just moderate returns of 3% for 2015E. The domestic economy should be strong and a good source of opportunity for investors as real incomes rise, particularly relative to the more internationally exposed stocks where the strength of the USD is likely to weigh on earnings.
8) In terms of themes, positioning for dollar strength and US relative economic strength are common across the markets. For the US this makes domestic stocks more attractive, particularly relative to those with high European sales growth (GSTHAINT v GSTHWEUR). For Asia it is reflected in our recommendation to be long Asia stocks with high US exposure and underweight those with high Europe revenues (GSSZAPUS v GSSZAPEU). In Europe our international basket of stocks that has high global exposure and benefits from Euro weakness also reflects this relative growth and currency divergence (GSSTEURO v SXXE) while in Japan we like a weak yen beneficiaries basket (GSJPFXW1).
9) Another theme which is reflected across markets is the ongoing desire for income and cash return in a world of near zero rates. In the US capturing companies buying back shares or delivering high cash returns has proved a good strategy over the past year and remains attractive (GSTHCASH/SPX). The shareholder return theme is also reflected in Kathy and team's recommendation to be long stocks generating superior shareholder return (GSJPSHHR) as well as the dividend yield and growth basket in Europe (GSSTHIDY/SXXP).
10) Amongst the key risks politics features more highly than generally in the past. Geopolitical tensions could spill over into willingness to take risk. Europe has important elections next year in the UK, Greece, Spain and Italy. In Asia too there are important regional elections in 2015/16 while reform efforts will impact China, India and Indonesia. There are, of course, downside risks to growth too, but on balance we see these risks more skewed to the upside relative to what equity markets have priced. Another important upside risk along this dimension is the possible boost from lower energy prices (we forecast US$84/bbl average for Brent in 2015). Of course this boost is likely to be greatest for the US but should not be dismissed for other countries too.
11) In general we expect the macro backdrop to be supportive of low volatility and, with it, low dispersion. Alpha is therefore likely to be key in most markets. However the differences in market prospects and volatility curves mean that we recommend selling S&P500 calls to enhance US returns, while we In Europe, where the volatility curve is flatter, favour buying long dated calls on the Eurostoxx 50.
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Trade accordingly...
