Full episode: Market Call Tonight for Monday, September 25, 2017
Tyler Mordy, president and chief investment officer at Forstrong Global Asset Management
FOCUS: Exchange-traded funds
It has been a long - and many would say well-earned - period of outperformance for U.S. assets. Since 2009, America’s stocks and its currency have trounced their global counterparts. By early 2017, the U.S. dollar index had surged to a 14-year high as investors bet that Trump’s projected eye-watering fiscal expansion would prove a replay of early 1980s Reaganomics. Yet the big surprise of 2017 has been that the U.S. dollar has stopped rising. This is remarkable considering that the Fed is hiking rates and preparing to shrink its balance sheet.
What should investors make of this? There should be no doubt that America’s waning leadership plays a key role in the value of its currency. However, U.S. equities are set to underperform. Why? Three key drivers of U.S. equity outperformance are going into reverse:
- In recent years, the Fed was the most aggressive liquidity provider in the world - this is no longer the case. The Fed is now tightening, while most central banks are on hold.
- In recent years, the U.S. benefited from an extraordinarily competitive currency - this is no longer the case. In a very short period, the U.S. dollar has gone from being significantly undervalued against almost all currencies to now being overvalued against the likes of the euro and the yen.
- In recent years, U.S. equities were attractively priced - this is no longer the case.
Where may the next phase of outperformance direct itself? Europe and Asia are the most likely candidates - these are regions that have cheap currencies, are showing signs of earnings and economic acceleration and trade on much cheaper valuations.
FINANCIAL SELECT SECTOR SPDR FUND (XLF.US)
Most recent purchase: September 20, 2016 at US$19.32.
Overall, Trump will have far less impact on the global economy than originally envisioned by markets. But it is clear that reduced regulation will be the key support for business confidence, rather than lower taxes and public investment programs. As such, Trump’s sectoral impact will be substantial. From that perspective, U.S. policy should support financials and homebuilders, be neutral for tech and multinationals and be negative for some manufacturing exporters, infrastructure companies and energy (as prices should stay soft while supply continues to ratchet up).
To summarize, U.S. financials should benefit from:
- Oversold sentiment
- Higher interest rates
- Reduced regulation
ISHARES MSCI EUROPE FINANCIALS SECTOR INDEX (EUFN.US)
Most recent purchase: June 20, 2017 at $21.40.
Europe has been mired in seemingly endless turmoil since 2008. The Sovereign Debt Crisis, fiscal austerity measures and a massive inflow of Syrian refugees have weighed on economic and geopolitical stability. As a result, real GDP in the Eurozone took over eight years to eclipse the high watermark set in 2008, while the rise of nationalist political parties threaten the future of European integration.
However, a number of factors bode well for European financials longer term. With encouraging economic momentum materializing (and dispersed across countries and sectors) and the risk of a Eurozone breakup receding, the financial sector should be buoyed by improving consumer and business confidence translating into a pickup in credit growth. Europe’s underperformance since the global financial crisis has left a fair amount of slack in the economy, allowing for an extended period of catch-up growth without a great risk of overheating.
The gradual normalization of ECB monetary policy should help bolster net interest margins, while a loosening regulatory environment in the U.S. may put competitive pressure on European regulators to follow suit. On aggregate, balance sheet strength has improved in recent years, as demonstrated by rising tier 1 capital ratios and falling NPL ratios, providing a more solid base for renewed lending activities. However, potential contagion from at-risk Italian banks cannot be taken lightly, as NPLs have risen by more than 500 per cent over the last seven years.
ISHARES MSCI SWEDEN INDEX (EWD.US)
Most recent purchase: September 25, 2017 at $35.50.
In addition to the current stimulative monetary policy tailwinds, Sweden stands to benefit from a rebound in Eurozone growth and improving German consumer demand. Sweden is a highly industrialized nation, which levers their economy to the European business cycle. Industrial companies represent about a third of the nation’s market cap.
Germany is Sweden’s top export destination. Their current unemployment rate is the lowest it has been in over two decades, and consumer confidence has been trending higher since early 2016. PMIs are firmly in expansion territory and year-over-year import growth has averaged around 10 per cent over the past five months. This environment should be supportive of German demand and thus Swedish exports.
Additionally, Swedish companies have a very strong reputation for innovation, ranking second in the world behind South Korea in the 2017 Bloomberg Innovation Index. This should help protect against rapid industrial automation (and potentially yield a competitive advantage), which threatens the viability of “midstream” participants in global value chains. Sweden is fiscally solid, operating a budget surplus. Public debt-to-GDP of aroudn 42 per cent is one of the lowest readings in the developed world, while keeping an independent currency provides competitive flexibility versus EMU countries.
Lastly, Sweden imports 100 per cent of its crude oil needs (they are a net exporter of refined petrol). The nation should therefore benefit from the current “lower for longer” environment.
PAST PICKS: SEPTEMBER 20, 2016
DEUTSCHE X-TRACKERS HARVEST CSI300 CHINA A-SHARES ETF (ASHR.US)
- Then: $24.59
- Now: $28.97
- Return: 17.81%
- Total return: 18.65%
iSHARES MSCI INDIA ETF (INDA.US)
- Then: $29.41
- Now: $32.78
- Return: 11.45%
- Total return: 12.20%
POWERSHARES SENIOR LOAN PORTFOLIO (BKLN.US)
- Then: $23.14
- Now: $23.06
- Return: -0.32%
- Total return: 3.30%
TOTAL RETURN AVERAGE: 11.38%
Horizons Managed Global Opportunities ETF (HGM.TO)
Performance as of: September 22, 2017
1 month: 0.97% fund
1 year: 7.06% fund
Since inception (Aug. 25/15): 13.03% fund (6.06% annualized)
*Returns are net of fees, on a net asset value basis (including reinvested dividents)
TOP HOLDINGS AND WEIGHTINGS
- iShares MSCI Japan ETF (EWJ.US): 9.54%
- VanEck Vectors ChinaAMC CSI 300 ETF (PEK.US): 7.94%
- iShares China Large-Cap ETF (FXI.US): 7.86%
- iShares MSCI EAFE Small-Cap ETF (SCZ.O): 7.42%
- iShares MSCI Brazil Capped ETF (EWZ.US): 5.92%