Curb Your Enthusiasm
08/26/2009 1:00 pm EST
Alexander Young, international equity strategist at Standard and Poor's, argues that future market gains will be harder to come by. His top pick is Brazil.
With investors bracing for the worst, overseas economic data and first-half earnings per share (EPS) releases easily topped depressed consensus expectations, reinforcing the view that the global economy is on the mend. This paved the way for significant international P/E expansion, as investors anticipate rising EPS leverage in the midst of a gradually recovering global economy, in our view.
However, there is a downside—months of exceeding low consensus expectations means that future forecasts will increase. As such, low expectations are a luxury that investors can no longer enjoy now that the EPS bar has skyrocketed. Specifically, 2010 international consensus EPS growth expectations soared to 27.2% from a mere 1.5% in January since analysts positively reassessed the earnings prospects of every major foreign geographic region in the world. The world economy is broadly expected to rebound from a front-end loaded 2.6% real GDP decline in 2009 to an expansion of 2% in 2010. The recovery trajectory should steepen sharply in the fourth quarter of 2009.
In addition, from a valuation perspective, while we think 2010 P/E multiples remain reasonable, in our view, future P/E expansion is likely to be more gradual since we think the 2010 EPS outlook remains very limited. Given that low forward multiples are predicated on a major 2010 profit rebound, we think expanding valuations won’t be seen until it becomes clearer that 2010 consensus EPS expectations are achievable.
This is likely to lead to a slower pace of ascent through year-end, characterized by increasing choppiness. Lastly, from a sentiment standpoint, global equity volatility has fallen back in line with October 2007 levels, which was the month global stock markets peaked. We believe this reflects increasing investor complacency and raises the likelihood of more muted gains through year end.
We continue to favor emerging-market (EM) equities within the international space, with a regional preference for Asia and Latin America over Emerging Europe, the Middle East, and Africa. At the country level, we continue to favor Brazil.
Year-to-date through August 12, EM equities rose 48.2% compared with a 16.6% increase in developed overseas stocks. S&P Equity Strategy believes drivers include faster, more reliable economic growth thanks to superior EM domestic momentum at a time of weakening external demand. This combined with lower valuations fueled the strong outperformance, in our view.