Foresight May 2022: macro themes and market outlook

Market sentiment has tumbled in recent months as uncertainty soared and volatility spiked—U.S. equities haven’t been spared. Proponents of the asset class are right to note that valuations have contracted to the point where they’re almost in line with historical averages and that the United States remains the developed market with the most attractive growth profile. Even so, we believe that concerns about a slowdown over the second half of the year and tightening financial conditions justify a more cautious stance that’s closer to a neutral or underweight position on a tactical basis. On a structural basis, the United States has the healthiest long-term economic profile in the developed world; however, relative valuation and an expected depreciation in the greenback, particularly against other key developed-market currencies over the longer term, remain headwinds to the asset class.

The Canadian equity market’s exposure to commodities, whose prices are markedly higher than six months ago, provides attractive upside, making it an appealing asset class on a shorter-term basis. Despite a more modest long-term growth profile relative to the United States, we continue to find Canadian equities attractive because of their supportive dividend profile and reasonable valuations. From a currency perspective, an appreciating Canadian dollar could provide attractive short- and long-term support to the asset class.

In our view, visibility around European equities remains shrouded by the fog of war. Valuations remain attractive relative to U.S. equities—risks around disruptions that are directly related to the conflict and the secondary effects of these dynamics fully justify the discount. In the intermediate term, we fully expect that any significant reduction in geopolitical risk, a resumption of the post-COVID-19 recovery, and ongoing fiscal support will lead to a period of outperformance. That said, there’s no evidence to suggest we could get there quickly. Longer term, the asset class offers an attractive dividend profile and a stronger euro would enhance its appeal; however, the region’s weak structural growth profile remains a meaningful offset to those tailwinds, thereby justifying a neutral stance.

This asset class is levered to manufacturing and global trade impulse, which remain constrained by supply chain disruptions. Meanwhile, ongoing economic uncertainty in China, which represents a large part of the emerging-market (EM) equities universe, is also a concern, as are political issues in Brazil. All things considered, we believe a near-term neutral stance is warranted; however, evidence of improved supply chain dynamics and stabilizing global growth could materially improve the outlook for EM equities, especially in view of current valuations. We continue to believe that EM equities remain appealing from a strategic perspective. Valuations remain inexpensive, and the asset class’s growth and dividend profiles are attractive over our five-year forecast period. A structurally weaker U.S. dollar (USD) would also provide a modest tailwind to this asset class.

Japanese equities should in theory provide an intriguing opportunity to investors: Any stabilization in global growth, the yen’s sizable depreciation so far this year, and continued massive monetary and fiscal support could provide upside to the asset class. We believe investors should be on the lookout for any evidence that the aforementioned factors have begun to drive performance. Structural factors in favor of Japanese equities include inexpensive valuation, a possible appreciation in the yen, continued improvement in corporate governance, and generous share buyback programs. Unfortunately, these factors are offset by Japan’s anemic growth profile. From a three- to five-year perspective, we continue to have a neutral view of the asset class, albeit with a slightly positive bias.

Chinese equities underperformed in recent months as a result of deteriorating growth prospects. In our view, any signs that Beijing could be taking a step back from reforms that could undermine market sentiment, a relaxation of current COVID-zero policy, evidence that the current wave of coronavirus infection is flattening out, or a reacceleration in the global inventory cycle could lead to a period of outperformance. We’ve long maintained that Chinese growth will need to decelerate to enable the economy to rebalance from an industrial growth model to a more consumption-led model. We also expect the renminbi to depreciate modestly over the next three to five years. As such, we remain neutral on the asset class.