The best equity opportunities may be in regions with better growth potential and more attractive valuations.
U.S. equity markets surprised many analysts with their strength in 2017, gaining 21.8 per cent including dividends (13.8 per cent in Canadian dollar terms) 1 – but, as advisors frequently remind their clients, past performance is not necessarily indicative of future returns. So where will the best opportunities be in 2018? The global economy experienced synchronized growth in 2017, with economic data improving nearly everywhere, and this momentum is expected to continue through 2018 as indicated by the Markit Purchasing Managers’ Index (PMI), a gauge of private-sector manufacturing health. Yet stocks in many global economies have significantly lower trailing price-to-earnings (P/E) ratios than stocks in the United States. Lower valuations, as measured by P/E, mean that investors can buy stocks at a more reasonable price.
The price-to-earnings ratio, also referred to as a stock’s earnings multiple, is calculated by dividing a stock’s share price by the company’s per-share earnings. The P/E ratio expresses the amount an investor has to pay for a dollar of earnings. So, if a company has a P/E ratio of 10x, investors who buy at the current share price are prepared to pay $10 for $1 of current earnings. The P/E ratio of the S&P 500 Index, based on the previous 12 months of reported earnings (the trailing P/E), was 21.83x on January 1, 2018.*
Strong international equity outlook
In comparison to the United States, equities in other countries may provide greater potential returns going forward. In January 2018, for the first time since late 2010, Manulife Investments’ Capital Markets and Strategy Team recommended that portfolios overweight international equities relative to U.S. equities due to growing international earnings, continued momentum of global economic growth, and the strength of global manufacturing and trade data.
Importantly, the Capital Markets and Strategy team points out, “Relative valuation is more attractive now than at any point during this cycle. When looking at the trailing 12-month P/E ratio (positive earnings only) between the MSCI EAFE Index and the S&P 500 Index, the differential is the widest it’s been in favour of international equities since the bottom of the market in 2009.” 2
The team’s projection for global equity returns during 2018 is in upper single digits with risk to the upside. “We would suggest favouring the improved opportunity set within the international equity markets of Europe, Japan and Asia modestly over the U.S., and both over Canada,” the team concludes.3
Areas of opportunity from Manulife Asset Management
In Europe, David Hussey, Head of International Core Equities, believes some of the best opportunities for global investors may be in commodities, including mining and oil and gas, thanks to attractive dividend yields reinforced by healthy cash flow at current oil prices. Hussey also sees value in U.K. stocks thanks to relatively low prices caused by the move towards Brexit.
Edward Ritchie, Managing Director and Lead Advisor for Manulife Asset Management’s Japanese Equity Strategies, sees strong demand benefiting Japanese companies that manufacture industrial robots and semiconductors, as well as continued growth in the consumer sector. More broadly across Asia, Ronald CC Chan, Chief Investment Officer, Equities, Asia (ex-Japan), likes the structural economic growth story in China, South Korea and Indonesia.
Emerging markets performed strongly in 2017 thanks to improving margins, profitability and business confidence, says Kathryn Langridge, Senior Portfolio Manager and Head of Global Emerging Markets Equity. She’s finding opportunities in the financial sector because of rising net interest margins and lending activity, and attractive valuations in key markets.
Of course every investor’s needs are different, but it’s worth evaluating your clients’ asset allocations to make sure you’re comfortable with the balance of U.S. and international equities and to ensure that your clients are exposed to the best opportunities for equity market growth. To dive deeper into the investment potential of international equities, download AdvisorCafe and look at the Market Intelligence Report.