International Equity Commentary: March 2014

Equities See Upside as Most Economic Indicators Remain Positive

International equity prices were little changed in March as investors reassessed the outlook for corporate earnings growth in light of the sharp price gains in select markets last year. There are growing concerns about the sustainability of high equity valuations in select sectors, such as technology and the biotechnology segment of healthcare. While many companies in these sectors continue to see excellent revenue growth, investors are becoming more cautious about their earnings outlook. At the same time, concerns about reduced capital flows into international equities as a result of an early rate hike by the U.S. Federal Reserve have faded. Minutes from the most recent Fed meeting indicate almost unanimous support for maintaining low interest rates until the unemployment rate declines further. Labor markets in the U.S. recovered further in March and retail sales exceeded expectations, which should lift the export outlook for the rest of the world. Economic trends from Europe continued to be healthy while Japan is seeing slower than expected growth.

Global manufacturing activity continued to expand in March, though the pace of expansion moderated. The U.S. and the Euro-zone maintained the pace of output growth, while Japan saw a slowdown. Among the emerging countries, factory output was mostly stagnant in China and Korea while Russia reported a decline. Factory output continued to rise in India, Indonesia, Mexico, Brazil, and Taiwan. The global services activity also continued to expand at a healthy pace in March, helped by gains in the U.S. and China.

Near-term Outlook

While select emerging economies continue to face slower growth, the global economic growth outlook appears to have stabilized after the subdued signals at the beginning of this year. The moderate pace of growth is likely to sustain in the Euro-zone, as consumer and business sentiment have improved. While the high unemployment rates could restrict gains in domestic consumption, improvement in global demand could lift exports from the region. The U.K. is set to see the fastest growth among the major developed countries this year. Japanese growth this year may depend on the extent of the decline in consumer spending after the consumption tax hike in April. Among the emerging economies, China is likely to see slower growth when compared to last year as exports have been unexpectedly weak during the first quarter. Russia is expected to see a slowdown as economic sanctions start hurting business sentiment and capital flows, while subdued commodity prices should lower the growth rates in Brazil and South Africa. The outlook for countries such as India and Indonesia could improve if the expected political changes materialize after elections scheduled this year. The International Monetary Fund has marginally lowered its global growth forecasts for this year as well as 2015.

The European Central Bank and the Bank of Japan did not initiate additional monetary measures at their recent policy meetings, opting to wait for additional data before making a decision. However, current trends indicate that the pressure on both central banks for expanding their monetary support is likely to increase. Inflation in the Euro-zone is well below target, and is not expected to rise appreciably as the economies should expand only at a moderate pace. Consumer spending growth in Japan has faded after a spurt during the first half of last year. To achieve its stated inflation target of 2 percent, the Bank of Japan may have to consider expanding its quantitative programs further. Policy actions by these two central banks could have more influence on global capital flows, even as the U.S. Fed is set to wind down its bond purchases before the end of this year.

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