Investors cn learn a lot from history. Looking back at the first quarter of 2009, many investors fretting about the oweful state of the global economy failed to focus on the things that matter: valuation and rapid acceleration of global policy momentum. As it turned out, these very factors created the backdrop for the sharp global equity rally over the past six months.
Given the heights that world equity prices have reached,investors are unsurprisingly getting wary. Admittedly, the valuation case has weakened. But global policy effectiveness has not waned.Rather,it is shifting from not waned. Rather,it is shifting from the China-led successes of the firt half of 2009 to a broader story, with US policy achievements emerging recently.
This leaves the prospect for another leg in the global rally, driven by continued momentum in US economic and earnings data.
For the year to date, economic recovery momentum has been key to identifying out-performing markets. Earlier in the year,news of US and Chinese economic stuimulus set the stage for a bottoming in global markets. But with Chinese stimulus coming sooner and more aggres-sively, MSCI [formerly Morgan Stanley Capital International] China surged 35 per cent in the first half of 2009, outpacing MSCI World's meagre 5 per cent.
But as Chinese policy stabilises, Wadhington's efforts during the late first quarter of 2009 are starting to ramp up US growth momentum. This can be seen in the rapid expansion of the Institute of Supply Management's New Orders Index in July and again in August. The index suggests that US job market concerns may start to be addressed soon, providing further support to earnings reports due next month (September).
Since March 2009, US company profits have been a key driver of market performance. During the first quarter 2009 earnings season from April to mid-May, world equities surged 18 per cent. Similarly, stocks rallied 12 per cent in the next earning season from July to mid-August. In total, on a compounded basis, earnings season-rallies have accounted for nearly two-thirds of the 52 per cent rise in globa equities(through August results next month, Tobias Levkovich, Citi's US equity strategist, believes earnings expectation upgrades could continur into the fall, potentially catalysing the next leg of the rally.
The starting of the transition of global recovery from one drive solely by China to a more balanced US/Chkina model has led to US equities bginning to outperform Chinese stocks sincke mid-year. MSCI US rose 11.5 per cent (through August 21),exceeding a 5.7 per cent increase in MSCI China.
So while investors are understandably cautiou expected news flow sugests caution will not be rewarded in the coming months. Asian stocks are likely to pariticipate again in the next upswing. However, they may not lead as they did in the first half of 2009. Rather, US equities, which wrelatively lacklus tre early this year, may sparkle.
But the US recovery, while appearing increasingly entrenchd, is still expected to be moderate. Hence, identifying stocks that currently under-prece even the modest recovery expescted, is crucial in the next stage of the rally.
Despite our optimism, we admit the global recovery story for 2010 must strengthen further to sustain the rally. China,already grappling with rapid loan growth, must moderate its aggressive easing policy and continue to build a domestic consumer base. As for the Us,it needs to transition from a stimulus-led recovery to a private sector-driven demand story.
On balance, while concerns exist on the horizon, upcoming news flow is expected to show US and global recovery acelerating, leaving the balance between risk and reward in favour of the reward camp through yar-end, creating an opportunity for invetors to broaden their focus from the past winners of emerging markets to include the opportunities in the US.
NORMAN VILLAMIN is head of investment analysis and advice,wealth management, Asia-Pacific,Citi.
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